2017 – A watershed year for the Eurozone?
by Mark Causer
The start of each year ushers in a new series of opportunities, challenges and a continuation of past themes.
Calendar year 2017 will be no exception.
If I were to name the one thing that stood out for me in 2016, I would have to cheat and say there were two;
Donald Trump’s surprise win, being elevated into arguably the highest office in the land; and
Brexit– the UK’s decision to withdraw from the European Union. I would suggest both events will offer up longer term questions!
I mention Brexit, but we have already heard Grexit (Greece). Will there be sufficient grounds well for Itexit, Frexit, Gexit and Nexit (Italy, France, German and Netherlands withdrawal from the EU) in 2017?
Let’s consider this.
Arguably, the European Union (EU) is the second largest economy in the world (if treated as a single market) in nominal terms and according to Purchasing Power Parity (PPP). In 2016 (according to the International Monetary Fund) the EU’s GDP was estimated to be €16.5 trillion (nominal). This represents just shy of 23% of nominal Global GDP.
So it is fair to say that what happens in this region really does matter to us all.
But if we ask ourselves, how well do we really know the region? Could we name the EU founding members from that small town in the Netherlands (Maastricht) on 1 November 1993? Who are the top three economic powers in the EU? Most of us will know world leaders such as Abe (Japan), Obama/Trump (USA), Cameron/May (UK), Putin (Russia), Modi (India) and Jinping (China), but how many of us could actually name the leaders of the big three – Germany, France and Italy?
It is impossible to predict with a high degree of accuracy, events that will shape our future, but with the EU as a major global economic player, we should better appreciate where some of the world’s volatility is coming from and what’s causing it. Importantly, some investment managers CAN grow wealth in ALL market conditions.
2016 may well have been the year of the populist vote, but we suspect that there could be more to come in the next 12 months.
Let’s examine the Federal government elections held in some of the founder member states of the EU and try and understand a little better what is going on and whether this has the ability to materially impact the political and economic landscape of Europe and the rest of the world in 2017.
[As an aside, what we do know is that the British Prime Minister has pledged to trigger Article 50 (Britain's complex negotiations to exit the EU can only begin when Article 50 of the Treaty of Lisbon is formally triggered by the UK) in March, which officially starts the process of the UK exiting the EU.
The first test will come in March with the Dutch elections. Populist, anti-Islam, far right, Member of Parliament Geert Wilders, will be one political figure to watch. Wilders’ Freedom Party (PVV) has risen strongly in the polls since he was tried and convicted of discrimination, late last year. A December poll found they would pick up 36 out of 150 seats in the lower house of their parliament, making it the biggest single political group in the new set-up.
Before the trial began on October 31, the PVV was credited with 27 seats. Since then and based on a recent Maurice de Hond poll (Netherlands' most famous pollster), the PVV is projected to secure 36 out of the 150 seats – a substantial lead over the next largest political party. Wilders has promised to immediately pull the Netherlands out of the EU if he becomes prime minister. He was quoted as saying, “we are not sovereign any more – we are not even allowed to form our own immigration policy or even close our borders and I would do that”.
General consensus is that another, more mainstream political party will form a coalition government to keep Wilders out of power, should his party remain in the lead. The same poll put Prime Minister Mark Rutte’s Liberals in second with 23 seats (down from 40 seats). The Labour Party, the junior coalition partners, would attract 10 seats (down from the current 35 seats). The country would be left with a much more unstable political set-up as a result.
In light of events last year (Trump and Brexit), should we really listen too closely to the polls?
Up next is France, in May. The National Front, led by Marine Le Pen, is expected to go to a second round in the presidential election, against the conservative Francois Fillon. [An interesting side note and an old rule of French politics, no sitting prime minister has ever been elected president. François Fillon, isn’t the current sitting PM, but was Prime Minister under Nicolas Sarkozy!]
The far-right leader was one of the first politicians to congratulate Donald Trump on his election in the US, saying in the aftermath of the businessman’s shock win that it “shows that people are taking their future back”.
Like Wilders, Le Pen also wants to withdraw France from the Eurozone and has called for a referendum on France’s membership of the European Union. Le Pen has stated that if elected President, her very first foreign trip would be to Brussels to start dismantling France’s existing relationship with the European Union. Some of Le Pen’s other views are she is opposed to multiculturalism, and before Christmas proposed that the children of illegal immigrants in France should be refused public school places. “I’ve got nothing against foreigners but I say to them – if you come to our country, don’t expect that you will be taken care of, treated (by the health system) and that your children will be educated for free,” Le Pen said.
“That’s finished now; it’s the end of playtime”
Current polls and logic are against Le Pen (likely to lose to Francois Fillon) – the same logic was against Brexit and Donald Trump. As matter of history, the Le Pen’s have form. Her father, Jean-Marie Le Pen was beaten into the presidency in 2002 by Jacques Chirac to keep Le Pen’s Front National party out of the top job.
Another interesting side note is that, Le Pen’s niece, Marion Le Pen is also making a name for herself, also right-wing and member of Front National. Marion Le Pen was France’s youngest ever MP and her herself has gathered a lot of the populist vote in her electorate.
The popular view is that Angela Merkel is likely to be returned to a fourth term as Chancellor, but is likely to lose seats. This brings some normality to the EU.
However, in the wake of the recent attack in Berlin, the anti-immigrant Alternative for Germany Party has been surging in the polls – is it possible she could be beaten?
While observers may be predicting a Merkel win in Germany (and a Le Pen loss in France), once again, current polling systems have been widely discredited after predicting a Remain vote in the Brexit referendum and a Clinton win in the US. It would be fair to say that Donald Trump’s election proved that there is no natural limit on the growth of populist movements.
In early December we saw Matteo Renzi resign (think David Cameron, UK, take two) after a crushing defeat in their referendum on constitutional reform, handing over power to little know Paolo Gentiloni. Paolo is Italy’s sixth prime minister in less than a decade and staggeringly, the 64th Government since the end of WWII. It is very possible that Gentiloni’s tenure will be short lived against a rising tide of Italy’s populist parties demanding a snap election – or at least another referendum for the battle weary population.
In all honesty, Italy does have some serious issues to address and address them quickly. The next couple of weeks could well shape their longer term future.
On 13 January, rating agency DBRS will conclude its review of Italy. DBRS is a globally recognised provider of credit rating is the only agency that still has Italy on an A-rating.
Any downgrade from here could mean a larger ‘haircut’ is imposed by the European Central Bank on Italian sovereign bonds (and other assets) – an unfavorable austerity outcome for the population, further fuelling the right-wing support.
The ‘caretaker’ government has had to approve a bank rescue fund of up to EUR$20bn (1.2% of GDP) to be used first for Monte dei Paschi di Siena, the world’s oldest surviving bank.
Several of the country's largest corporate firms (including banks [their largest, UniCredit is looking at slashing up to 14,000 jobs by 2019 to shore up its finances] and their airline which is considering job cuts of up to 1,600) are getting set to slash jobs as the nation faces uncertainty over political decision making and its worsening financial crisis.
The youth unemployment rate has rocketed to 39 per cent with 627,000 people under the age of 25 out of work in the crisis hit country – the general unemployment rate is 12.5%.
Additionally Ericsson AB could be set to cut a quarter of its local workforce equating to 1,000 jobs after losing a contract to manage Italy's largest wireless network.
The country is $2 trillion in Government debt worth more than 130% of GDP, and the entire Italian banking system is, for all intents and purposes, insolvent.
If by some chance Italy can get over these issues or at least the major threats, then the consensus view is that markets can focus on a solid fundamental outlook, improving economic strength in the U.S., continued China growth at a relatively healthy rate (albeit it down on past years) – both very positive environment for risk assets.
Financial Keys feels that it is important to at least acknowledge the risks posed by Europe. It is this very thought process that we take into the many investment manager meetings. Opinions on markets will always differ, BUT if we don’t feel that the investment manager(s) has a grasp of the situation or is unable to change course due to stringent investment mandates, then we will not invest your money here.
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