Position: Short France (EWQ)
1. European Union Unemployment Rates
While unemployment is a lagging indicator, it is nevertheless a formidable metric that can tell quite a story about a country’s “health”. While country statistical offices may have different measures for calculating employment, we’ve used Eurostat data below to present the high-low divergence that exists across Europe. As we pointed out in our Q2 Theme call Bearish Enough on Spain?, a high rate of unemployment, especially among persons 18-35, can have significant longer-term TAIL implications on economic growth. Simply said, higher levels of unemployment beget lower levels of consumer spending and tax revenue; pile on government austerity measures, ie cutting spending and levying higher taxes (which we’ve recently seen from Spain, UK, Italy, and Portugal) and we believe you have a cocktail that will push growth prospects further out on the curve (chart 1).
We’d draw your attention to the Baltic countries in chart 2 below, in particular. Over the trailing 6 months based on most current readings, Estonia, Lithuania, and Latvia show some of the largest gains in unemployment rates. While the Baltic economies account for only 0.5% of total European Union’s GDP according to IMF data, investment risk is embedded in the region’s continued leverage to western European mortgages and loans, especially Swedish banks, and is nevertheless not insignificant. Remember that the Baltic countries experienced some of the largest contraction in GDP last year. We have seen sequential improvement in GDP for these countries over the last 3 quarters off bombed out year-over-year levels, which has helped contribute to the outperformance of the underlying equity markets YTD, yet we’d caution that rising unemployment will eat into the region’s potential growth prospects.
One country that stands out in chart 2 is Germany. As we’ve noted in our recent work, the decline in German unemployment over the last months is decidedly bullish, however last week we sold our position in Germany due to the drag we expect from the continent’s debt-laden peers.
Another key take away from the EU unemployment divergences is that a one-size-fits-all monetary policy is clearly not working in the Eurozone. This is a longer term structural negative for the Euro. We believe that there will be increasing conflict between countries within the Eurozone as their economies recover at different rates (or don’t recover at all) as the monetary union continues to weaken due to a lack of political solidarity.
2. ECB Deposit Levels Ramp to Historical High
Although the Europeans in collaboration with the IMF issued their $1 trillion “loan” facility in early May, European capital markets continue to shake day-to-day. Data from the ECB today may confirm investor worries as banks in the Eurozone parked record levels of cash with the ECB. Overnight deposits totaled €320.4 billion yesterday versus €316.4 billion in the previous day (chart 3).
As the chart points out, the flight of banks to safety began with Lehman and the financial crisis blowing out in the Fall of 2008 and has continued since then. With Euribor heading to a new YTD high of 0.706% today, it’s clear banks are cautious on the road ahead. Our call remains that Greece is not an anomaly, but rather that the fiscal imbalances of much larger economies such as Spain, France, and Italy are next, followed by the USA in 3-6 months.
We’ve positioned ourselves to take advantage of weakness in European markets. We’re currently short France via the etf EWQ and have been short Spain (EWP) in our virtual portfolio this year.
Matthew Hedrick
Analyst