France is coming apart – here’s one way to play it

Last Monday, workers at a Goodyear tyre factory in France who were called “lazy and overpaid” by their American boss lost the plot completely. They grabbed a production manager, a human resources manager, and two extremely heavy tractor tyres, and barricaded themselves into a room in the back of the factory.

This is the return of ‘bossnapping’, a French industrial relations strategy which first came to prominence in 2009. The problem got so bad back then that the president was forced to intervene (although polls at the time showed the public was on the side of the kidnappers).

The Goodyear workers were understandably angry that the plant was to be shut. But I’d suggest that maybe bossnapping is a symptom of a bigger problem in French industry.

Germany streaks ahead

Labour relations in France have not been good, as you might have guessed. At the time of the eurozone’s creation, German labour costs were higher than they were in France. Yet now, French labour costs are higher.

And France is running the largest budget deficit in the eurozone. The government just can’t seem to live within its means. Each new week brings further bad news for France, but across the border, it’s a very different story.

I often talk about the ailing West – and I’m probably guilty of lumping many, really quite different economies together. But it’s getting harder to ignore one stand-out economy: Germany.

France and Germany have driven the EU forward for years. Their economies were similar in size and they wanted the same things for Europe. But now, they’re starting to move apart. This week, Germany reported rising exports for the fourth month in a row. You see, unlike so many Western economies, Germany actually runs a trade surplus. That is, it exports far more than it imports.

And it’s really set the cat among the pigeons in Europe. The EU is investigating this surplus – and claims they could even mete out a hefty fine if the Germans don’t start to rein in their success!

Readers who hopped aboard my short France/ long Germany trade are starting to reap serious rewards right now.

Stuck with the euro

As the following chart shows (plotting Germany’s DAX in red and the French CAC in blue), the French markets have stalled. Meanwhile, Germany powers ahead:

German DAX index v French CAC index

Source: Digitallook

In the past, the currency system would have helped to close the gap between France and Germany.

Before the euro, if Germany had a strong economy with a large trade surplus then the deutschmark would rise relative to its trading partners. And the franc would fall. But, of course, these guys are all in the same currency now. The euro is too weak for Germany, and too strong for France. This is a fundamental problem. And it’s not going away.

France is not ‘cheap’

Pundits who say the DAX is ‘overbought’ simply because the chart seems to be going up, appear to be missing out on the big picture. I have made the point several times. Even now that France’s CAC appears to have stalled, the fact is, the market is getting more and more expensive. Especially if you compare it to Germany’s DAX.

When I opened my long/short trade, both markets were valued at 12 times earnings. Yet now, with French industry struggling to maintain profitability, the market is actually trading at nearly 19 times earnings! As for Germany, its price/earnings (PE) ratio has moved up to 16 times earnings. On a PE measure, Germany is now considerably cheaper than France.

In the long term, I can actually see the German market trading higher than France (in PE terms). In other words, the healthy German economy will lead to strong profits in future, and higher stock prices in PE terms. So I see plenty more mileage in the pairs trade I described (I’ll show how it works in a second).

And bear in mind, a long-short pairs trade is what we call ‘market neutral’ – that is, if markets crash everywhere, then we should be spared the carnage. That’s because the long position (on German stocks) should be offset by the corresponding short position on French stocks. This trade is all about relative performance.

How to take advantage

Placing a spread bet or contract for difference (CFD) is probably the easiest way to take advantage of the discrepancy between the French and German market.

As I write, my spread-betting company shows the French CAC 40 trading at 4,246 and the German DAX 30 trading at 9,472. So if you buy the DAX at £1 per point, then effectively your exposure is £9,472 (simply multiply the stake by the value of the index).

If I want to go short an equal value of the CAC, then I need to place a down-bet of £2.2 per point – ie, my short exposure is then £2.2 x 4,246 = £9,341 which is near as damn it equal and opposite to my long DAX.

For a full explanation on how spread betting works, click here. And of course, all the normal caveats apply. Spread betting and CFD companies allow you to operate with considerable leverage, and that means you could lose more money than you put into the account. So spread betting amplifies the potential for both gains and losses. And if the market turns against you, The amount you gain or lose could be large relative to the amount you put in.

And of course, the discrepancy may in fact be there for a reason (it’s just that I can’t see what it is!).

  • Fai

    Elegant trade expression – have agree with sentiments on the CAC. Looking at Credit Default Swaps on CAC too!

  • chazza

    I live in France and experience the daily stupidities of French over regulation. The French government advertises on Facebook for ideas of how to simplify things; I tried to register but it all seemed too complicated to bother with.

    Apart from food and wine I try to buy as much as possible in England for savings of 50% or greater. Within France, competition is discouraged. Resale price maintenance is rife.

  • Doris McMuffin

    I think this is a very promising punt and very well spotted by Bangt. However the reason I did not pursue (via spread betting which is all I know) is the various spreads, backwardation costs, sp/bet interest costs all add up to quite a high percentage guaranteed cost (with time) working against me. If the bet continues as well as it is, it will not matter but it’s quite an expensive bet to make, which makes it a bit more risky than it first appears.

  • Realist

    I’m surprised France hasn’t come apart at the seams well before now. They have a very strong Union contingent, which are as backward thinking as our own Unions. Things are more expensive there, but they are able to afford the extra cost because they have more disposable income due to not having ludicrous house prices.