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Position: Long Germany (EWG)

Per Wikipedia, undertow is defined as “a strong subsurface flow of water returning seaward from shore, often as result of wave action.”  If the strong subsurface flow in the UK is the threat of stagflation as the UK economy is forecast for meek growth alongside expanding inflation and a looming double-digit budget deficit to GDP ratio, more surface waves could result, including those from yesterday’s general election result.

Number 10 Downing Street

Yesterday’s election yielded no clear majority government, or the 326 seats needed (of the 650 seats in the House of Commons) to gain an overall majority in Parliament. Although Cameron won the most seats with 291 versus Gordon Brown (251) and Nick Clegg (51), the inability of one party to form a majority sets the stage for three likely outcomes:

  1. Gordon Brown and his incumbent government may continue to govern because no party won parliamentary majority, perhaps with a hand-shake agreement with another party for support like the Liberal Democrats.
  2. Brown may offer his resignation to the Queen and suggest a new government, likely David Cameron.
  3. The Queen could overthrow Brown’s minority government in her "Queen’s Speech” on May 25th in favor of another party (the Conservatives).

While a hung parliament was largely priced in, the uncertainty on the political and economic direction of the UK could likely put further downward pressure on the Pound, which is down -9.2% versus the USD year-to-date (or flat versus the EUR) and also on the equity market (the FTSE is down 5% YTD).

Inflation Popping

The UK’s Producer Price Index for April was released today and the figures remind us why we want to steer clear of this economy. The Input Price Index jumped 13.1% in April year-over-year and output rose 5.7% versus the previous year and suggest that producers will pass on higher input costs to consumers.  The most current reading of CPI is 3.4% in March Y/Y.

UK Undertow - UK PPI APRIL

Clearly, whoever emerges as the winner in the UK will have the challenge of righting an ailing economy.  The UK has a hefty budget deficit that will likely reach ~13% of GDP this year with gross debt climbing to some 73% of GDP which would force the government into a very difficult position of cutting the deficit (expediently) while not smothering growth (think Greece, Portugal, Spain, USA...).  While the UK debates spewed idealism on the country’s future, the reality of the country’s anemic fundamentals is formidable.

Matthew Hedrick
Analyst