Eurozone Crisis Report Card

Ryan DresselRyan Dressel, Investment Analyst, Brinker Capital

In January 2013 Amy Magnotta wrote in detail about how the actions of the European Central Bank (ECB) finally gave the markets confidence that policy makers could get their sovereign debt problems under control.[1] The purpose of this blog is to measure the progress of the ECB’s actions, as well as other critical steps taken to resolve the Eurozone crisis.

Maintaining the Euro: A+
The markets put a lot of faith in the comments made by the head of the ECB Mario Draghi in July, 2012. Draghi stated that he would “Pledge to do whatever it takes to preserve the euro.” These words have proven to be monumental in preserving the euro as a currency. Following his announcement, the ECB still had to put together a plan that would be approved by the ECB’s governing council (comprised of banking representatives from each of the 18 EU countries)[2]. The politics of the approval essentially boiled down to whether or not each council member supported the euro as a currency. Draghi’s plan ultimately passed when Germany’s Chancellor, Angela Merkel, endorsed it in September 2012.[3] The stabilization of the euro boosted lending and borrowing for European banks, and allowed governments to introduce necessary economic reforms outlined in the plan.

Since the plan was approved, the euro’s value versus the U.S. Dollar has continued to rise; reaching levels last seen in 2011. There is still some debate as to whether or not the currency will last over the long term, but for now its stability has helped avoid the worst possible outcome (financial collapse). There are several key elections coming up over the next month, which could renew the threat of breaking up the currency if anti-EU officials are elected.

Government Deficit Levels: B
The average Eurozone government deficit came in at 3.0% in 2013, which was down from 3.7% in 2012. Budgets will need to remain tight for years to come.

Corporate Earnings: B
The MSCI Europe All Cap Index has returned 27.46% in 2013 and 5.01% so far in 2014 (as of last week). The Euro area also recorded first quarter 2014 GDP growth at +0.2% (-1.2% in Q1 2013).[4] This indicates that companies in Europe have established some positive earnings growth since the peak of the crisis. On a global scale, Europe looks like an attractive market for growth.

Dressel_EuroZone_ReportCard_5.30.14

Unemployment: C
Unemployment in the Eurozone has stabilized, but has not improved significantly enough to overcome its structural problems. The best improvements have come out of Spain, Ireland and Portugal due to a variety of reasons. In Ireland, emigration has helped reduce jobless claims while a majority of economic sectors increased employment growth. In Spain, the increased competitiveness in the manufacturing sector has been a large contributor. Portugal has seen a broad reduction in unemployment stemming from the strict labor reforms mandated by the ECB in exchange for bailout packages. These reforms are increasing worker hours, cutting overtime payments, reducing holidays, and giving companies the ability to replace poorly performing employees.[5]

Dressel_EuroZone_ReportCard_5.30.14_1[6]

There are also some important fundamental factors detracting from the overall labor market recovery. The large divide between temporary workers and permanent workers in many Eurozone countries has made labor markets especially difficult to reform. This is likely due to a mismatch of skills between employers and workers. High employment taxes and conservative decision-making by local governments and corporations have also created challenges for the recovery.

Additional Reading: Euro Area Labor Markets

Debt Levels: D
Total accumulated public debt in the Eurozone has actually gotten worse since the ECB’s plan was introduced. In 2013 it was 92.6% of gross domestic product, up from 90.7% in 2012. The stated European Union limit is 60%, which reflects the extremely high amount of government borrowing required to stabilize their economies.

Overall Recovery Progress: B-
On a positive note, governments are finally able to participate in bond markets without the fear of bankruptcy looming. Banks are lending again. Unemployment appears to have peaked and political officials recognize the importance of improving economic progress.

Unlike the 2008 U.S. recovery however, progress is noticeably slower. The social unrest, slow decision making, low confidence levels, and now geopolitical risks in Ukraine have hampered the recovery. When you consider the financial state of Europe less than two years ago, you have to give the ECB, and Europe in general, some credit. Things are slowly heading in the right direction.

The views expressed are those of Brinker Capital and are for informational purposes only. Holdings are subject to change.

[1] January 4, 2013. “Is Europe on the Mend?” http://blog.brinkercapital.com/2013/01/04/is-europe-on-the-mend/
[2]
European Central Bank. http://www.ecb.europa.eu/ecb/orga/decisions/govc/html/index.en.html
[3] September 6, 2012. “Technical features of Outright Monetary Transactions. European Central Bank.” http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html
[4] Eurostat
[5] August 6, 2012. “Portugal Enforces Labour Reforms but More Demanded.” http://www.wsws.org/en/articles/2012/08/port-a06.html
[6] Eurostat (provided by Google Public Data)

Demographic Changes Looming (Part One)

10.17.13_BlogRyan Dressel, Investment Analyst, Brinker Capital

This is part one in a two-part blog series.

In 2013, it seems the financial headlines have been dominated lately by policy changes of the Federal Reserve, dysfunction in Washington, China’s threat of a hard economic landing, or Europe’s ongoing sovereign debt crisis.  Lost in these headlines are some major demographic trends that are already under way, or are looming on the horizon over the next decade.  Many of these changes will have a profound impact on investors, governments and societies in the United States and abroad.

Aging Population

The world’s developed countries are aging quite quickly.  As of the most recent 2010 census, the median age in the U.S. is 37.1, compared to 28.2 in 1970.  This is actually fairly low in comparison to some of the world’s other developed nations.

10.17.13_Demographics_Part1

This is not a huge surprise as the baby boomer generation is reaching middle age.  It does, however, have some large implications that need to be watched closely by investors, companies and governments over the next decade.

What implications does this trend have for the U.S. and abroad?  For starters, an aging population will put a large strain on healthcare costs as the number of people who need access Medicare increases.  A study by Health Affairs cites aging population as a main driver of rising health care cost forecasts.  It projects national health care spending to grow at an average annual rate of 5.8% over the 2012 – 2022 period (currently near 4% in 2013).  By 2022 health care spending financed by federal, state, and local governments is projected to account for 49% of total national health expenditures and to reach a total of $2.4 trillion.[1]

Second, smaller subsequent generations (Gen X, Gen Y) will have to increase productivity to maintain the current low, single-digit GDP growth in the United States.  The responsibilities of the baby boomer generation upon retirement will naturally have to be absorbed by younger generations.  A 2013 study released by the Georgetown Center on Education and the Workforce (CEW) indicates that this trend is already occurring. It cites that there are more job openings created as a result of retirements today than in the 1990s.[2] The U.S. can fuel this productivity by increasing competitiveness in manufacturing, and using competitive advantages such as low energy costs and technological advancements.

Third, an increased focus will be put on fixed income and absolute return investment strategies, especially if the U.S is entering a rising interest-rate environment as many economists believe.  As populations age, their risk tolerance will naturally decrease as people need to plan for their years in retirement.  In 2012, only 7% of households aged 65 or older were willing to take above-average or substantial investment risk, compared to 25% of households in which the household head was between 35-49 years old.  Despite a growing life expectancy, the retirement age is still 65. This has major causes for concern for social security, capital gains tax policies, and corporate pension plans.  Subsequent generations will need to place an increased importance on individual retirement saving should the program terms change, or disappear altogether.

Part two of this blog will look at two additional trends of urbanization and wealth inequality.


[1] Health Affairs.  National Health Expenditure Projections, 2012 – 22: Slow Growth Until Coverage Expands and Economy Improves. September 18, 2013.

[2] Georgetown Center on Education and the Workforce.
http://cew.georgetown.edu/failuretolaunch/. September 30, 2013.

Beginning of a ‘Great Rotation’?

Joe PreisserJoe Preisser, Brinker Capital

As the share prices of companies listed in the United States rose this week, to heights last seen in October of 2007, speculation has run rampant that a so called ‘Great Rotation’ from fixed income to equities may have commenced.

The continued easing of Europe’s sovereign debt crisis, combined with positive corporate earnings surprises and the temporary extension of our nation’s borrowing limit, has helped to quell a measure of the uncertainty that has plagued market participants during the course of the last few years. Tangible evidence of this phenomenon can be found in the marked decline of the Chicago Board Options Exchange Market Volatility Index (VIX), commonly referred to as the “fear gauge”, which is currently trading far below its historical average. The steep drop in expected market volatility suggests that investors believe to a large degree that many of the potential problems facing the global economy are already priced into current valuations, and as such have set expectations of the possibility of any external shocks to be quite low. This state of affairs has led directly to an increased appetite for risk within the market, which has culminated in strong inflows into equity funds. According to the Wall Street Journal, “For the week ended January 16, U.S. investors moved a net $3.8 billion into equity mutual funds. That followed the $7.5 billion inflows in the previous week, along with another $10.8 billion directed to exchange traded funds. Add it up and you’re looking at the biggest two-week inflow into stocks since April 2000” (January 24, 2013).

Although the movement of money into equities this year has been quite strong, whether or not this is the beginning of a significant reallocation from fixed income remains to be seen. Despite the flight of dollars into stocks, yields, which move inversely to price, on both U.S. Treasury and corporate debt have risen only moderately, and bond funds this year have not experienced the type of drawdowns that would be expected if investors were truly rotating from one asset class to another. In fact, what has transpired speaks to the contrary, as although inflows to the space have slowed from last year, they remain robust. According to an article in Barron’s published this week, “Bond funds, meanwhile, attracted $4.63 billion in net new cash. Bond mutual funds collected $4.21 billion of that sum, compared to the previous week’s inflows of $5.45 billion” (January 18, 2013). One possible explanation for the hesitation to exit the fixed income space is the lingering concern among investors over the looming fiscal fight in Washington D.C. and the potential damage to the global economy if common ground is not found. According to a recent Bloomberg News survey, “Global investors say the state of the U.S. government’s finances is the greatest risk to the world economy and almost half are curbing their investments in response to continuing budget battles” (January 22, 2013).

If begun in earnest, a rotation by investors from fixed income to equities would certainly present a powerful catalyst to carry share prices significantly higher; however caution is currently warranted in making such an assertion, as a potentially serious macro-economic risk continues inside the proverbial ‘beltway’. If the budget impasses in the United States is bridged in a responsible way, and the caustic partisanship currently gripping Washington broken, the full potential of the American economy may be realized and this reallocation truly undertaken. David Tepper, who runs the $15 billion dollar Apoloosa Management LP was quoted by Bloomberg News, “This country is on the verge of an explosion of greatness” (January 22, 2013).