Email of the day
Comment of the Day

August 26 2016

Commentary by David Fuller

Email of the day

More on the next shoe to drop in Europe:

Yesterday I wrote about why I think the UK should leave the EU as rapidly as possible by declaring unilateral free trade. There is another reason that I did not mention which I believe makes it urgent that we do so. I voted 'remain' but I am a pragmatist interested among other things in protecting my financial assets. The ill-conceived Euro and the dysfunctional currency block is an accident waiting to happen and one senses that time is running out. A new phase to the drama may unfold soon.
The financial press has focused on Italy's woes and its coming referendum. This article from back in June in the FT outlines the issues and the risks that come with the referendum.

The Eurosceptic Five Star Movement wants to take Italy out of the Euro but remain in the EU.The party topped the polls in a recent survey with 30.6% support versus 29.8% for the Renzi's ruling Democratic Party.

Whatever the outcome of that poll in October, Italy will remain a huge risk to the Euro. Back in the month of May you posted in your daily comment an article by Ambrose Evans-Pritchard who wrote that "Leaving the Euro may be the only way to avert a catastrophic de-industrialization of the country before it is too late."

Industrial production in Italy is back to where it was in the 1980s.

And here's another one to watch - see attachment and article at this website:

Portugal rocked the Euro boat a few years ago, and concern seems to be reappearing, signaled as ever by the bond market. Yields have been rising over the past couple of weeks. The article opens with:

"The fate of Portugal rests in the hands of DBRS, the last remaining credit rating agency assigning an investment grade rating to its sovereign debt (Fitch, Moody's and S&P have all lowered the country's debt rating to junk).  Due to a requirement that participant countries have an IG rating from at least 1 rating agency, the DBRS rating is literally the only thing allowing Portugal's bonds to remain eligible for the European Central Bank's 1.7 trillion euro bond buying program.  DBRS is set to update its Portugal rating on October 21 and investors in Portugal sovereign risk are starting to get a little nervous."

DBRS are probably feeling the pressure, though with the EU's form of ignoring and reinterpreting rules to shore up the system there must be some doubt the outcome will be as black and white as the article states. But we have been warned. As with Italy, it seems unlikely the Euro can work for Portugal in the mid-term. The article states:

"The socialist minority government that came to power in November 2015 has 

not helped the situation by:

raising the minimum wage, increasing the number of public holidays 

and reversing other key reforms,

that will make it more difficult for the country to meet its EU fiscal targets.  

To be sure, the collapse in oil prices have indirectly taken a toll on Portugal as 

well with exports to it's 4th largest trading partner, Angola, falling by 42% in the 

first half of 2016." 

In summary, the potential for turmoil around the Euro at any time suggests it would be wise for Britain to declare universal free trade and exit the EU as rapidly as possible.

For investors, the question is what can we do to protect ourselves from these or other events as the Euro unravels, as it surely must do, the only issue is the timing. Here are my thoughts and it would be great to have your input too David. The euro comprises 57.6% of the dollar index so any downward pressure on the Euro will have implications for the dollar and hence for asset classes which are priced in dollars. Strengthening USD does seem to be an outcome, possibly later this year but very likely in the mid-term, with consequent attraction towards USD denominated financial assets including the US stock markets, precious metals and US real estate.  Money could move out of the Eurozone into other markets though I read that German bonds are a popular buy on speculation that any eventual total collapse in the Euro will lead to reinstatement of the Deutschmark at a premium. GBP could begin to look a safe haven again. The USA and the dollar could be the biggest draw for financial assets though if the dollar rises too far and too fast that will leave the Fed in a very difficult situation, unable to lower already rock-bottom rates to slow dollar gains and also unable to raise rates if the economy overheats. Eventually a strong dollar could damage the US economy and possibly precipitate the next cyclical bear market. I think that is some way off so let's enjoy this possibly final and remunerating phase of one of the longest bull markets in history.

David Fuller's view

Thanks for this detailed email.  Worldwide free trade is certainly our economic goal and this message cannot be repeated too often.  I also believe that corporations will rapidly redevelop these international business skills, especially with the full diplomatic cooperation of the Conservative government.  I think we should exit the EU in a tactically sensible strategy, which is even more important than haste, especially as time is now on our side.  Theresa May and her appointed team probably have this in hand and she will need the support of many Remain voters, in the interests of the country. 

Re investments, you certainly will have this service’s input.  Also, Eoin and I always welcome the views of subscribers, from which we have all benefitted over the years.  I think one starts with the right questions.  For instance, investors have been wary of EU countries for some time.  So, at what point will they view a breakup of the EU as economic salvation for its better economies and companies?  Also, could the Euro become a firm currency in a considerably slimmed down EU led by Germany, or will the single currency be scrapped because it was always going to cause havoc without the federal state that the majority of Europeans never wanted?   

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