Great, that’s over now, right? Phew! If only…
The banking crisis in Cyprus shook financial markets last week, triggering heavy selling around the globe. The crisis seemingly came out of nowhere. Well, at least it seemed that way to those that are uninformed.
To those that pay attention to the underlying data, it is no surprise to see the European debt crisis rear its ugly head again. As we have been telling investors in our reports and at our trading seminars – the market’s rebound in the last nine months is not proof that the problems in Europe have been solved – rather just that the problems have mostly moved to the back of investors’ minds.
Investor sentiment is certainly important, and was probably overly bearish last year – but just imagining that a problem doesn’t exist doesn’t mean it has gone away.
We are of the firm belief that it will be a long, arduous, hard slog in Europe to get the collective European economy back on track. And until it’s all done and dusted, investors should be prepared for more flare-ups.
The turning point in the European crisis was in late July last year when ECB President Super Mario uttered infamous line ‘…the ECB is ready to do whatever it takes to preserve the Euro….and believe me it will be enough’.
That one line, delivered to reporters as he was walking down the corridor from an ECB conference is the single biggest factor behind the Australian market’s 25% rise since mid-last year.
With that, investors were reassured that the problem in Europe has been solved.
The truth is that little has changed to the underlying debt problems in Europe – outside of a boost in confidence that that problem won’t descend into global financial system chaos.
Many European countries have taken (or been forced to take) the brave decision to undertake austerity programs. This essentially means governments are looking to cut spending and raise taxed in order to reduce budget deficits (what happens when governments spend more than they earn).
We believe this is a more appropriate strategy to deal with a debt crisis – as opposed to the American stimulus solution where the approach is to pay off too much debt with….more debt.
But taking a look at some economic indicators really illustrates how difficult it will be for European countries to first balance their books and then eventually make major headway into paying back its debt.
Let’s start with the indicator that garners the most attention; GDP growth – ie the rate at which an economy is growing (or shrinking).
The chart above shows the world’s estimate of how Europe’s economy will grow in 2013. A year ago, financial markets were expecting Europe to grow by 1% this year. Not an impressive number at all, but at least it’s something. Unfortunately expectations for economic performance in Europe are only deteriorating. Worryingly, most of the downward revision has come since Super Mario’s infamous speech.
Where do we sit now? Well, the market is now factoring in Europe to shrink by 0.2% this year. And we won’t make you think of the trajectory of the trend and where that suggests growth (shrinkage) expectations will be later in the year.
When an economy is shrinking, there’s less goods and services being produced or delivered. Less business requires less employees.
The chart above shows the unemployment rate across the Euro zone. We can see that in the last 12 months there has been a clear jump from 11% to 12%, with no real signs of a end to the rise. In some countries (Spain and Greece), the unemployment rate is over 25%. And for those lucky enough to remain employed, wages growth has been anaemic.
The significance of this is twofold. Firstly, the less people that have jobs, the less people pay tax. To compound matters, the more people unemployed, the more benefits need to be paid out by the government.
Which brings us to our last chart – budget deficits.
This shows the market’s expectations for how bad Europe will be at balancing its books in 2013. The chart is a budget deficit to GDP ratio for the Euro zone, ie compared to the size of the joint economy, how much extra debt will Europe need to take on to finance its tax/spending shortfall.
At least this chart shows stabilisation, rather than clear deterioration. But of course more debt is only going to make the problem of paying off too much debt that much harder.
Now, most governments will never clear out their national debts. Often it is less important how much a government owes as how risky the government is seen as being right now. That is because if a country (or region like the Euro zone) is seen as being low risk, it can borrow money cheaply and use that new money to pay back old debts. And then borrow more money to pack back the new debts ad infinitum.
Luckily these borrowing rates (what the finance world knows as bond yields), are coming down. But if the economic picture continues to worsen – and these charts above clearly show that the trends are only deteriorating – then be prepared for more bad news to emerge from our friends over in Europe.
This editorial was published on Monday the 24th March – Access the investors report FREE for 7 days