The Czech Republic’s ruling coalition toppled yesterday after Prime Minister Mirek Topolanek received a vote of no confidence in parliament. Topolanek’s coalition fell out of favor due to its inability to pass the reform it promised and to deliver leadership in the country’s economic slow-down.
The ousting of leadership in Eastern Europe is nothing new. Over the weekend Hungarian Prime Minister Ferenc Gyurcsany stepped down, proclaiming that if he can help to create a new government to address the country’s economic woes, then “this is how it has to be done,” and Latvia swore in a new PM with finance experience a few weeks ago.
The destruction and/or repositioning of individuals or governing coalitions throughout the region adds to the political destabilization of Eastern Europe, especially to outside investors peering in on a region that has multiple negative macro fundamentals piling up, many of which have been grossly highlighted by the media. While it’s net positive that governments are finally making the push to address their economic woes through new leadership, the decisions have come too late. Due to demand destruction within the Eurozone—the biggest market for most Eastern European countries—there is simply no market for their goods. This has reduced output, increased unemployment, and in turn sent bond yields soaring and credit ratings falling as investors expect a higher risk premium. The balance has sent GDPs tumbling further downward for this year and next.
The net of this development, which has seen budget and account deficits shoot up, has left many in the region with one option—look West, ie the EU and international organizations for aid. Today Romania received a $27 Billion bailout from the IMF and EU. The loan will help to reel in a budget deficit that was projected to hit 9% of GDP this year to ~4.5%. As a point of reference, the EU mandates that EU countries maintain an account deficit less than 3% of total GDP. Last year the IMF bailed out Latvia, Hungary, Serbia, Ukraine, and Belarus.
The good news for countries like Romania is that the IMF announced today that it will loosen the strings attached to its loans (like insisting on government spending cuts), double credit lines, and let governments borrow more up front. The new Flexible Credit Line credit facility may be aptly rolled out for the April 2 G20 summit and in response to the daily negative economic data points coming from regions like Eastern Europe.
In particular, the Baltic states look extremely troubled. Latvia’s economy shrank 10.3% in the last quarter, the EU’s worst decline, and is expected to fall to 15% this year. Lithuania’s economy is expected to fall 9% this year and its credit rating was cut yesterday by Standard & Poor’s to BBB from BBB+. Increasingly many argue that these currencies, which have kept fixed pegs to the Euro throughout the global financial crisis, need to either abandon and float them or reconfigure their pegs lower to be better in line with economic contraction. Latvia is the most indebted among Eastern European nations with external debt equivalent to 130% GDP according to data compiled by Brown Brothers Harriman & Co. The ratio for Estonia is 108% and 70% for Lithuania. The ‘Domino Effect,’ meaning if one Baltic state was allowed to fail, all would because their economies are highly correlated, is a serious concern for the EU.
The G20 Summit should give us more guidance on the state of Europe’s recovery, especially how Western Europe will deal with its own decline as it aids Eastern Europe. The IMF revised GDP to shrink 3.2% in the 16-Nation region. Germany, historically with the region’s strongest economy, is forecast by the Kiel Institute to decline 3.7% this year (or 6-7% by Commerzbank) and investor confidence out today shows sequential decline. Total euro-area exports fell 11% in January from the previous month, and the UK’s CPI reading of +3.2% in February Y/Y will challenge the country’s inflation target of 2%. The outlook is certainly bleak across the entire European board.
Yet Eastern European indices have been trading higher in March. Romania is UP +24.8%; Czech Republic +21.5; and Poland 12.7%; and Hungary +4.8%. YTD Romania is DOWN -18.5%; Hungary -12.8%; Poland -10.8%; and Czech Republic -9.3% and currency devaluation versus the Euro remains a real concern, especially with those loans denominated in Swiss Francs and Euros from western states.
We’ll continue to diagnose the Eastern European patient to determine if the March bounces in indices are simply trading off positive US economic news, or their own organic growth stories amid this global recession. Additionally we’ll be watching for European leaders at the G20 next week to address the Union’s response to economic recovery. At a pre- G20 summit in Brussels last week leaders insisted that the proposed €400 Billion for Eurozone recovery had to be given time to kick in. The issue of the European Presidency, which was expected to be held by Czech PM Topolanek till the end June, must surely come up now that he has been ousted. The Czech Republic may prove to be a destabilizing force on the Union due to the no confidence vote and acting Czech President Vaclav Klaus’s European Union skepticism.
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Prime Minister Aso is hard at work on a third stimulus program as carmakers and electronics producers step up the pace of layoffs, but the truth is that there is little that the government can do now to fix the problems that Japan faces. As an export dependent economy which sells big ticket consumer products to wealthy European and North American markets, the Japanese are hostage to declining demand from their clients that can only be offset by a weakened Yen.
We have been short the Japanese equity market –and wrong, for the past week because we anticipated that the BOJ’s attempts to weaken the Yen through a treasury repurchase program would not stem the tide of Dollar-devaluation driven by the Fed’s own massive repurchase. Japanese public debt currently stands at 170% of GDP, so a 1.8 trillion Yen per month debt purchase by BOJ seems unlikely in the long term to protect yields or the currency as the government prepares additional stimulus measures that may easily add 15 to 20 trillion in debt issuance in this round alone.
We have also heavily discounted the impact of any increase in internal demand spurred by the BOJ’s bank loan program; which I see as essentially a margin-call-reset for underwater stock portfolios that cannot possibly convince Japanese consumers to stop hoarding savings to the extent that it will offset contracting external demand meaningfully.
The Yen has weakened against the dollar and we are now down by nearly -4% on our short as the Japanese equity markets are trading on a one factor basis, a factor which I was flat footed on tactically and which has cost us.
We continue to view the Japanese market negatively. After the “lost decade” another prolonged period of rising unemployment (and, critically, underemployment) will wreak further social havoc -keeping a lid on domestic consumption and leaving Japanese firms to wait for a rebound in US and EU spending.
Importantly, the competitive capacities of the ASEAN manufacturing centers (not to mention South Korea and Taiwan) seem better postured top participate in the growth of Chinese consumption. We continue to have a negative bias on the Japanese equity markets, but must trade it tactically. We remain short the Japanese etf, EWJ.
Today, the Commerce Department reported that new home sales nationwide rebounded by 4.7% in February after hitting a record low in January (the government also revised January's sales pace for new homes to 322,000 units, up from the 309,000). The February sales pace was still down 41.1% compared with February 2008.
We also saw a small improvement in Inventories of unsold homes as they fell by 2.9% to 330,000 in February; a 12.2 month supply given the current pace of sales. Last February, there was a 9.2-month supply of unsold homes. Given the potential for revisions, these government statistics require 3-5 months of data to establish trend line sales.
This statistic alone is not an affirmation of the bottom, so let’s look at the environment for signs of a potential recovery in housing:
(1) Overall affordability measures are the best in years
(2) Mortgage rates are at generational lows
(3) Mortgage applications are up significantly
(4) Significant government incentives
(5) Homebuilders are up significantly in the past two months
(6) Lower home prices
The last piece of the housing puzzle will be price. When consumers feel that the value of home prices have stopped going down, the incentive to buy improves dramatically. We believe the inflection point on price, as measured by the Case/Shiller index, will occur in 2Q09.
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