Position: Long Germany (EWG)
While our macro team has been vocal on signaling global inflationary threats to keep your eyes on, today’s preliminary April report on German CPI confirms our bullish outlook based in part on the country’s favorable low inflation environment, registering +1.0% Y/Y, compared to +1.1% in March Y/Y, or a 10bps contraction month-over-month.
As we highlighted in a post yesterday, “Merkel’s Struggle with Greek Junk”, Greece is just the beginning of the sovereign debt issues we see ahead. Just today, Spain’s credit rating was downgraded by S&P to AA from AA+, and yesterday Greece and Portugal were reduced to BB+ (junk) and A-, respectively.
In the case of Greece, we believe the near-term weakness we’re seeing in government bond yields and the equity market (the Athex Composite is down -20.5% since 3/26), is overdone. While it is politically expedient for German Chancellor Angela Merkel to hard line Greece in receiving funds as her party campaigns for victory in an important state election on May 9th that addresses wasteful spending, we believe Germany’s contribution to Greece is inevitable. Note that Merkel did say today that “it’s completely clear that the negotiations between the Greek government, the European Commission and the IMF need to be speeded up now” and the Athex close up on the news by +63bps as many European equity markets fell as much as 2.5% today.
In view of the sovereign debt concerns, we continue to like Germany as a lower beta play on safety for an economy that should benefit from the government’s fiscal conservatism and an export base that should improve along with a weaker Euro (currently at a one-year low of $1.31), as companies benefit in margin from an environment of low inflation.