Europe's Core / Periphery Imbalances Going Parabolic

George Soros' recent speech on what created the Euro bubble (and how it will need to play out) is making the rounds (although he deleted the speech from his personal site for some reason, a pdf version is here). While I strongly suggest reading the whole thing, a key takeaway is that:

The authorities didn’t understand the nature of the euro crisis; they thought it is a fiscal problem while it is more of a banking problem and a problem of competitiveness.

The result is that the issues have not been addressed and problems have only gotten worse.

The real economy of the eurozone is declining while Germany is still booming. This means that the divergence is getting wider. The political and social dynamics are also working toward disintegration. Public opinion as expressed in recent election results is increasingly opposed to austerity and this trend is likely to grow until the policy is reversed. So something has to give.

Which can be easily seen in a variety of metrics, including unemployment which is shown in the below chart and is simply unbelievable. It shows the current unemployment rate of Spain (currently an unreal 24.3%) divided by Germany's (less than half 2005's level at 5.4%) going back to 2000. It was only 5 years ago that Spanish unemployment was actually lower than Germany's (though that employment coincided with a massive housing bubble in Spain funded by cheap German financing from excess German savings).

Source: Eurostat

How's That Austerity Working?

Bloomberg details:

The debt of the euro region rose last year to the highest since the start of the single currency as governments increased borrowing to plug budget deficits and fund bailouts of fellow nations crippled by the fiscal crisis.

The debt of the 17 euro nations climbed to 87.2 percent of gross domestic product in 2011 from 85.3 percent the previous year, official European Union figures showed today. That’s the highest since the euro was introduced in 1999. Greece topped the list with debt at 165.3 percent of GDP, while Estonia had the least at 6 percent of GDP.

Bloomberg continues...

Italy ended last year with the second-highest debt at 120.1 percent of GDP. Spain’s rose to 68.5 percent from 61.2 percent. Germany posted one of the only declines, with its debt shrinking to 81.2 percent from 83 percent, Eurostat said in the report. Only five euro-region nations -- Estonia, Luxembourg, Slovenia, Slovakia and Finland -- had debt within the euro- region’s limit of 60 percent of GDP.

This leaves indebted European countries in an awfully precarious situation.

On one hand they have limited firepower left with debt levels increasing relative to nominal GDP even as they push austerity measure (always important to remember the debt to GDP ratio will rise as long as debt increases more than GDP and that can be in the form of flat debt and declining GDP). On the other, even if the citizens throw out leaders that favor austerity, for those pro-growth, it is unlikely to help as it doesn't address the cause of the problem... the imbalances between countries with vastly different production capabilities, demographics, beliefs, yet a shared currency.

Source: Eurostat

Germany Needs to Consume

Bloomberg details:

European retail sales unexpectedly rebounded from four months of declines in January, as growth in France helped to offset a drop in Germany.

Sales rose 0.3 percent from December, when they fell a revised 0.5 percent, the European Union’s statistics office in Luxembourg said today.

Not as much good news in Germany:

In Germany, Europe’s largest economy, retail sales fell 1.6 percent from December, when they advanced 0.1 percent, today’s report showed.

Which means everything in Germany is apparently "normal" and rebalancing across European countries is still nowhere near happening.

Over the past 10 years, German retail sales neither rose nor fell more than 5% from January 2002 levels (see below) in real terms. On the other hand, we can see the extreme rise and fall of Greece retail sales, the surprising (recent) resilience of Irish retail sales after an even sharper rise, and the battle between Spain, Greece, and Portugal for furthest overall decline from 2002 levels (Spain data is missing over the past two months).

While I was well aware of the relative lack of personal consumption in Germany relative to investment and exports, it is still amazing to see how little retail sales have grown. No wonder the average German citizen doesn't want to pay for the rest of the European peripheral's "sins". On the other hand, those sins largely benefited German corporations that exported these goods.

The issue that you regularly hear about is the need for Europe to rebalance. Without the Euro, this would entail a rise in German currency which would make German exports more expensive and goods more affordable for the average German citizen (perhaps even leading to German imports from the periphery, though not sure what they really make that Germans would want). Without that flexibility, rather than a rise in sales in Germany, we may just see a continued decline in sales elsewhere.

Source: Eurostat

European Manufacturing Feeling the Downturn

Marketwatch details:

Industrial orders in the 17-nation euro zone fell 1.3% in November after a 1.5% rise in October, the European Union statistics agency Eurostat reported Tuesday. Compared to November 2010, orders fell 2.7%, the agency said. Economists had forecast a 2.3% monthly decline and a 2.8% year-on-year fall.

Since the European crisis re-emerged in mid-summer, the European core has seen a rather sharp drop off in new industrial orders, while Emerging Europe (and the UK / Ireland) have shown strength (note that Greece didn't release data for November, but was down 5% from July through October).

Source: Eurostat

The European Impact on Financials and Risk Assets

I wrote back in early October that financials have been an important factor in risk asset performance for the better part of the past four years. The below chart shows that since June, financials are still an important sector to keep an eye on, but that the sector appears to be driven (remarkably well) by the situation in Europe.

Source: Yahoo Finance

European Industrial New Orders Crumble

Industrial production within Europe for the month of September was ugly (see here), but nothing compared to new orders made during the same month (which leads to future production). The Economic Times details:

Euro zone industrial new orders slumped in September, the EU said on Wednesday, the deepest fall since December 2008 and far worse than economists had forecast, in the latest sign that Europe may be heading for a recession.

Orders in the 17 countries sharing the euro tumbled 6.4 percent in the month compared to August, well below expectations of a 2.5 percent fall, with Germany and France registering sharp contractions, the EU's Statistics Office Eurostat said.

"The scale of the deterioration is surprising," said Clemente de Lucia, an economist at BNP Paribas. "We are entering some kind of contraction in the last quarter of this year that will continue in the first quarter of next year," he said.

Interesting to note that the core of Europe appears to be doing much worse than the periphery (a reader noted that the core is where "stuff" is made").

Source: Eurostat

France is No Germany

FT Alphaville details:

The 30-year German bond yield is close to a record low, around 2.48 per cent at pixel time. France might be able to borrow for 30 years at just 4.4 per cent (i.e. hardly a distressed credit)… but the days of convergence are long gone.

European Recession?

Expect there to be a larger focus on European economic data in the coming months. With that in mind, Bloomberg details European industrial production for September:

European industrial production declined the most in 2 1/2 years in September, led by capital and consumer goods, as the sovereign-debt crisis pushed the economy toward a recession.

A few things to note in the above...

• Germany appears to have been severely impacted by broader European austerity
• Italy was crushed
• Eastern Europe (an area that was initially impacted more by the crisis) saw positive growth in industrial production

Warning: While my guess is the above is more of a trend than a blip, the data is backward looking (over a month ago) and just one data point, thus it will be important to see how this progresses.

Source: Eurostat

All Eyes on Europe

The lack of posts have been two-fold:

• I’ve been swamped
• I have been trying to wrap my head around the European situation (i.e. the slow moving car wreck)

While I don’t pretend to be an expert on Europe (though it was obvious enough to be asking the question back in January 2009 whether it was possible that a country would leave the Eurozone), below are my super high level thoughts.

In my opinion (the fact that this is only my opinion is key), it seems more and more likely that the only way the situation in Europe can be successfully resolved, is if the end result is a European fiscal union (this is just another way of saying that Germany needs to bail out those within the broader European Monetary Union if we are to avoid another systemic crisis). If this is the case, the obvious question becomes... is Germany willing to bail out the broader European Union?

The pros / cons of such a bailout for Germany can be broken down into at least two areas; political and economic.

Political

Short-term: Politically, it seems that the easier choice is for Germany to say no, as German citizens are broadly opposed to a bailout. However this is countered by existing politicians who have their legacy tied to the European Union and will likely do anything it takes to maintain that legacy.

Long-term: If Germans are to take a longer term view, a fiscal union helps maintain peace within the region (which was the whole point of the economic union to begin with). That is unless the economic ramifications of a bailout cause political tensions between countries in a scale that exceeds those benefits.


Economic

I have no clue whether the systemic issues that Germany would inevitably feel resulting from sovereign defaults in Europe are greater than the cost of a bail out.

Positives of a bailout for Germany include allowing Germany to maintain an undervalued currency, bailing out Europe = bailing out European trading partners (which maintain demand for German exports), and most important (in my opinion) effectively bailing out the European banking system that owns all the European sovereign debt (including German banks).

Negatives of a bailout include the cost (unless you believe this is just one big liquidity crisis, it will be very expensive) and there is no historical precedent that these countries would get their house in order (i.e. will this just happen again?). More important (in my opinion) is what happens if the broader European solvency issue infects the last remaining healthy European balance sheet (i.e. is a German bail out similar to Bank of America purchasing Countrywide).

Why a One Size Fits All Policy Doesn't Work

Source: Eurostat

European Debt Once Again Front and Center

Don't call me the Brett Favre of bloggers yet. I'm not officially back, but getting the itch and may post here and there (and likely more to be a long form post - we shall see). Not sure why the below is my first entry back (nothing epic or new about the below), but it piqued my interest as restructuring seems FINALLY likely to happen (thank goodness, especially for the individuals of Ireland who are currently in a severe downward spiral).

Bloomberg details the history of the liquidity solvency problem in the European periphery:

Today’s data brought the debt crisis back to where it started. Greece last year obtained a 110 billion-euro lifeline from European governments and the International Monetary Fund. Ireland followed with a 67.5 billion-euro package and Portugal is now negotiating for 80 billion euros in aid.

A bail out for Portugal? Must mean that things are improving (i.e. the bailouts helped) Greece and Ireland... or not.

Greece’s debt ballooned to 142.8 percent of GDP, the highest in the euro’s 12-year history, the EU figures showed. Ireland’s debt surged the most, by 30.6 percentage points to 96.2 percent of GDP.

What is interesting (to me) is that debt levels in Germany are almost (or at least in the ball park) of Portuguese and Irish levels at 83% of GDP. While Ireland is WAY over their heads with a death spiraling economy, Portugal has actually been relatively lockstep with Germany; Germany's GDP and public debt levels have grown 2.7% and 32% since 2007, Portugal's 1.9% and 39%.

Source: Eurostat

European Retail Sales Decline

Reuters details:

Euro zone retail sales unexpectedly fell in December with equal declines in food
and non-food sectors, a sign that consumers in the single currency bloc were reluctant to splurge even in the key holiday period.

The European Union's statistics office Eurostat said on Thursday retail sales in the 16 countries using the euro fell by 0.6 percent month-on-month, for a 0.9 percent year-on-year decline.

Economists polled by Reuters had expected a 0.5 percent month-on-month rise and a 0.2 percent increase year-on-year.

The new data came while European Central Bank policymakers met to decide on interest rates. Economists said they did not expect weak retail sales to prevent the ECB from issuing a warning on inflationary pressures.

The chart below shows the three month change by country and clearly shows the slowdown in aggregate demand within the region.

Source: Eurostat

Europe's Industrial Rebound: The Power of Mean Revision

RTT News details:

Eurozone industrial new order growth quickened in November, led by Portugal, Finland and Germany, official figures showed Monday. Industrial orders rose 2.1% month-on-month in November, after rising 1.4% in October, the European Union Statistical office Eurostat said. On an annual basis, industrial order growth accelerated to 19.9% from 14.8% recorded in the preceding month. The rise exceeded the 17.5% increase economists had forecast.

The below charts show that much of this is purely a rebound off lows, with a relatively strong relationship between those reporting strong results in 2010 off of lower figures in 2009.





Source: Eurostat

European Economic Rebound Slows

Nasdaq details:

The European Union grew by 0.4% over the 3rd quarter, declining from the 1.0% growth rate posted last quarter. The GDP figure just missed analysts´expectations of 0.5% forecasted ahead of time. Over the year, GDP over the EU remained unchanged as expected at 1.9%.

Source: Eurostat

Look Out for Eastern Europe

Missed this last week... Extremely strong industrial production out of eastern Europe...



A few points...

The Good

• It seems that everyone had been counting out Eastern Europe (including me)
• The European Union "should" allow lower GDP per capita countries (i.e. Eastern Europe) outpace higher GDP per capita countries simply by utilizing new technologies / open trade

The Bad

• The above chart shows the rebound off a large collapse, so it remains to be seen if this is a rebound or the start of a longer trend
• The above was before the Euro spiked up 15-20%, so we'll see if the drag of a stronger currency on exports impacts these countries

Source: Eurostat

European Manufacturing Rebound Hits Speed Bump

WSJ details:

New industrial orders in the euro zone posted their sharpest monthly drop for 19 months in July, led by a slump in orders for capital goods, official data showed Wednesday.

Factory orders dropped 2.4% from June—the sharpest decline since December 2008—but were 11.2% higher than in July a year earlier, the European Union's Eurostat statistics agency said. June's figures were also revised down slightly to show orders rose 2.4% month-to-month and 22.7% year-to-year.

The July figures were weaker than expected. Economists had predicted orders would be 1.6% lower from the previous month and 16.3% higher than a year earlier, according to a Dow Jones Newswires survey last week.

The figures appear to support the view that the euro zone's economic recovery is likely to lose some steam in the second half of the year, in part because of government spending cuts designed to reduce the size of countries' budget deficits.

Ignore Denmark below, which had grown 23.9% in June and is volatile due to aerospace purchases.

Over the longer term, we see that although production has rebounded significantly off lows, intermediate and capital goods production is still way below previous peaks.



A slow down combined with the recent surge in the Euro that will impact export price levels means that Europe will be facing some severe headwinds in coming months.

Source: Eurostat

Euro Area GDP Revised Higher

Reuters details:

Higher household spending and investment drove euro zone growth in the second quarter of 2010, while first quarter growth was also stronger than thought, but the expansion should slow in the second half of the year.

Year-on-year, the euro zone economy expanded 1.9 percent in the second quarter, rather than the previously estimated 1.7 percent, and grew 0.8 percent in the first quarter rather than the earlier reported 0.6 percent.

Gross domestic product in the 16-nation currency area grew 1.0 percent quarter-on-quarter in the April-June period, the fastest pace in four years, after an upwardly revised 0.3 percent in the first quarter.

Growth was driven by very strong figures in Germany, the currency area's biggest economy. Crisis-hit Greece was the only euro zone country to suffer contraction, although figures for Ireland were not available.

"Activity will probably lose momentum in the second half of the year," de Lucia said, pointing to a likely deceleration of growth in Germany, where activity largely relies on exports. Major export markets like China and the U.S. are slowing down.

Source: Eurostat

The Case for Developed Europe

Missed this the other day. Reuters details:

Euro zone industrial new orders rose more than expected during the month of June, data showed on Monday, boding well for economic growth in the third quarter of 2010.

Industrial orders in the 16-nation currency zone increased 2.5 percent month-on-month for a 22.6 percent annual gain, European Union statistics office Eurostat said.

"That's good. Shows we can take a lot of the second-quarter momentum into the second half," said Carsten Brzeski, economist at ING.

The data could point to another quarter of economic expansion as the euro zone recovers from its sovereign debt problems and the worst economic crisis in decades. Orders point to trends in activity as they translate into future production.

So the economy seems to be "recovering" (or at least not entering a depression). The importance of this non-depressionary environment? The market is (according to GMO's James Montier - one of my favorite out of the box writers) priced like it is.

To his latest missive (if you are not signed up, I recommend you do - bold mine):

Of course, as with all investments, the price you pay determines the attractiveness of the opportunity. The good news is that European dividends appear to be priced cheaply at the moment.

Exhibit 6 (go to his missive to see) shows the current pricing structure of European dividends (for the Eurostoxx 50, the vertical line marks the point at which we switch from actual dividends to the market’s implied view of dividends), and shows the experience of U.S. dividends during the Great d epression as a comparison. In essence, the market is saying that dividends will have virtually zero growth between now and 2019. This is a worse outcome than the U.S. witnessed in the wake of the Great Depression!

Source: Eurostat

European Consumption Stagnant

Bloomberg details:

European retail sales were unchanged in June as households reduced spending in Germany and France.

Sales in the 16-nation euro area showed no increase from May, when they rose 0.4 percent, the European Union’s statistics office in Luxembourg said today. That matched the median forecast of 19 economists in a Bloomberg News survey. From a year earlier, June retail sales gained 0.4 percent after rising 0.6 percent in May.

European consumers may remain reluctant to boost spending as companies continue to cut wage costs and eliminate jobs to shore up earnings. Unemployment held at 10 percent in June, the highest in almost 12 years.

While developed Europe consumption continues to stagnate, Eastern Europe has bounced back surprisingly well (albeit off of rather extreme lows).



Source: Eurostat

Europe's Pecking Order

Interesting stuff in the stress test results, outside of the results themselves. An example... the valuation haircuts used in the stress test on sovereign debt holdings. The absolute magnitude isn't nearly as interesting (to me) as the relative magnitude (i.e. Italy vs. the United Kingdom).

Source: Stress Test