Yesterday, my colleague Dominic Frisby looked at the state of the euro from the point of view of the charts. Today, I want to talk more about the political story.
Over here in Britain, Ukip has been the big story of the recent elections. But across the Channel, mainstream parties across the continent took a drubbing too.
Anti-austerity party Syriza topped the polls in Greece. The far-right Front National came first in France. Even in Germany, the Eurosceptic Alternative for Germany managed to grab seven seats in the European Parliament – while the neo-nazi NPD won a seat.
This matters. Until now, the working assumption has been that the euro crisis is over, solved by the clever manoeuvring of the European Central Bank (ECB).
But the results show that under the surface, Europe’s problems haven’t gone away. European citizens are fed up, and want change.
That could threaten the fragile peace – which in turn suggests that more radical action will be needed.
And that could end up being very profitable for investors with the guts to take advantage…
The European Central Bank hasn’t saved Europe yet
The ECB has bought Europe a lot of time with its threats to do “whatever it takes” to save the euro. The hope now seems to be that with growth returning, unemployment will fall and countries will be able to pay off their debts.
Trouble is, growth is nowhere near strong enough to make that happen. Eurozone-wide growth hit just 0.2% in the first quarter of this year. And that was mainly down to Germany.
France didn’t grow at all. Italy, Holland and Portugal’s economies all shrank.
The latest survey data tells a similar story. The overall purchasing managers’ index for the eurozone as a whole suggests moderate growth. But again, it’s largely down to strength in Germany. In France, the surveys imply that activity is weakening.
One lingering problem is the European banking system. There are fears that many institutions are hiding the fact that they are either bust, or close to it. The ECB has tried to fix this by carrying out a series of ‘stress tests’, designed to make sure that the banks can remain solvent under a series of gruelling economic conditions.
However, until now at least, it has been too easy to pass the tests. There have been several cases where banks got a clean bill of health, only to fold shortly afterwards.
And as Tom Walker of Martin Currie Global Portfolio Trust points out, if you compare US banks to European banks, you get a much better idea of just how much rubbish could still be sitting on European balance sheets.
In total, US banks have written down 16% of their pre-crash assets. In other words, they’ve accepted that the value of the stuff sitting on their books is nearly a fifth less than it was before 2008. European banks have only written down 6%.
Given that many European banks (especially those in Germany) were among the most enthusiastic buyers of junk like subprime, this suggests that they are still sitting on a mountain of dodgy assets that they are failing to disclose.
This might not matter while investor exuberance is driving demand for even the dodgiest assets higher. But if sentiment changes suddenly, then those banks could be in serious trouble. So the ECB is running yet another round of tests, with the results expected in October (this is the ‘asset quality review’, or AQR).
The trouble is, while we might get a better picture of the state of the banks, it’s also going to hold any recovery back. You see, if the banks are worried about having to raise more capital and write down more debt, then the last thing they want to do is lend more money to businesses and consumers.
Already, lending to firms is 3% down on the same time last year, while household borrowing is only up by 0.4%.
What will Draghi do next?
ECB boss Mario Draghi has hinted that he will do something at the next ECB meeting at the start of next month. Ideas from full-blown quantitative easing to negative interest rates have been floated in the papers.
But apparently, the latest idea to gain traction is something along the lines of the UK’s ‘funding for lending’ scheme. Under this, European banks would get access to cheap money from the ECB, on condition that they increase lending to the private sector.
But this probably won’t be enough. As Capital Economics points out, banks already have unlimited access to cheap money from the ECB, and they’re not using it. Germany may also insist on lots of conditions being attached, which would stop the scheme from being of much use to the countries who most need it.
However, the election results show that European voters are running out of patience faster than growth is returning. They’re not happy with the way things are, and the longer it goes on, the bigger the risk that we see a country once again agitating to leave the eurozone.
The best way to play money-printing in the eurozone
It’s hard to say whether or not Draghi will do anything radical at the next ECB meeting. But he is clearly not happy with the current situation, and is particularly keen to weaken the euro, which has fallen from its recent high of nearly $1.40 against the dollar, to just above $1.35.
The risk for anyone thinking of playing the currency is that if he doesn’t act at the next meeting, the euro could surge. So the timing of the move is tricky.
But in the longer run, the ECB is likely to have to act. And if it does loosen up monetary conditions, the obvious beneficiaries are European stock markets.
We’ve tipped both Italy and Spain in the past. They are more expensive than they were – trading on ten and 11 times long-term earnings respectively – but hardly at eye-watering valuations.
However, if you’re looking for the real bargain basement stuff, Greece is still the obvious one, trading on a cyclically-adjusted p/e ratio of only 4.5. It’s not one to stake the family fortune on, but it’s done very well in the last few years. The easiest way to play it is via the Lyxor ETF FTSE Athex 20 (Paris: GRE) exchange-traded fund (which I own myself).
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