O Euro!

Laments my friend David Kotok:

Euro: Requiem or Renewal?
March 30, 2013

In the last several weeks, a sequence of events involving Cyprus has triggered serious questions about the sustainability of the European Monetary Union (EMU). The events surrounding the finance ministers’ decision to levy taxes (i.e., partially confiscate deposits) on depositors in a Euro-system bank led to a sequence of blunders that have been well-recited in the press. There is no need to repeat the details here.

For readers who missed it, I do want to add this link to the personal observation of Edward Scicluna, finance minister of Malta, who was appointed by his country’s prime minister on March 13. His first action was to participate in the notorious Eurogroup meeting on Cyprus. See: http://www.timesofmalta.com/articles/view/20130319/opinion/cyprus-a-lesson-for-life.462258 . Source: http://www.timesofmalta.com , March 19.

In the Cyprus affair, we observe a defeat of the concept behind the Eurozone and the original European Union. It took half a century to create the European Union after WWII. The driving force was what the French call a “rapprochement” between formerly antagonistic parties. To put it simply, the Germans and French decided to stop killing each other after a thousand years of war. An economic union seemed the right way to go about attaining peace and prosperity. After centuries of destructive inflation outcomes, they realized credible money was absolutely necessary for this peaceful outcome to succeed.

That process led to the Maastricht Treaty (1992), the official adoption of the euro (1995), the final exchange-rate setting of the euro (1998), and the actual launch of the euro on January 1, 1999.

Eleven countries of the original fifteen in the newly formed European Union agreed to adopt the euro. The currency existed only in virtual form for the first three years and then enjoyed a nearly flawless transition to the physical version, which was immediately accepted. The results were stellar. Interest rates converged down to very low levels. Efficiencies resulted, because currency-exchange costs within the Eurozone were completely eliminated. More transparency in pricing and increased trade among the members of the Eurozone added to their economic growth rates. It was a high time for the euro.

In its first years the European Central Bank (ECB) was led by a Dutch central banker, Willem (Wim) Duisenberg, as president, and a French central banker, Christian Noyer, as vice president. The initial governing council of the ECB had a single purpose in mind, and they never violated it. They knew from history that they could not allow the new currency to be destroyed or inflated. They understood that it had to be hard and credible. They set about implementing that policy, regardless of short-term costs. The euro emerged in the early part of the first decade of the millennium as one of the strongest, most widely used, and most dependable currencies in the world.

Subsequently, there was a series of expansions of the Eurozone, which now comprises 17 nations. There also followed a softening of credit-quality restrictions and an easing of collateral rules. There has been apparent succumbing to political pressures. The Eurozone is not the same place it was when Duisenberg and Noyer led the ECB.

Fourteen years after the euro’s launch, we have the perception of currency weakness, coupled with an ongoing banking-system shock. This January, another Dutch central banker, Jeroen Dijsselbloem, became Chairman of the group of eurozone Finance Ministers. In the space of a few months he has undone all the good work started by his predecessor, Wim Duisenberg.

Dijesselbloem has a history. He nationalized a failed bank and insurance group, SNS Reaal, in February. There he wiped out the bondholders and shareholders. We have no arguments with that from our side. But when Dijesselbloem attacked the insured depositors in a Euro-system bank, he went too far.

“Taxing depositors is no different from outright confiscation of individual wealth. This type of action would not surprise anyone under a communist regime, but it is truly troubling in a supposedly free-market capitalist and lawful society.” Well said by Chen Zhao, Managing Editor, BCA Research. Readers please note that “of the 147 banking crises since 1970 tracked by the IMF, none inflicted losses on all depositors, irrespective of the amounts they held and the banks they were with.” The Economist (March 23) concluded that “depositors in weak banks in weak countries have every reason to worry about sudden raids on their savings.”

We agree. We advise clients to take no risk with their bank deposits to the extent they can avoid them.

So, what will the leadership of the Eurozone do now?

Is the euro dying? If that is the case, a requiem may be in order, as we watch it suffer a protracted, agonizing death. We could be seeing the early death throes in Greece and now in Cyprus, and we may soon see them elsewhere (perhaps in Slovenia, Malta, Spain, Italy, or other Eurozone nations). Each in turn may succumb to metastatic euro-failure disease.

Or is there a possibility of euro renewal? Could the Cyprus crisis and bank depositor confiscation policy act as a catalyst for change? The Cyprus events come on the heels of the Greek sovereign-debt default. Clearly that was not enough to trigger a change. Will the finance ministers of the Eurozone finally realize that they cannot continue to do what they have done in the past? Will they be cognizant of Einstein’s guidance that insanity is doing the same thing over and over again and expecting a different outcome?

Is Europe sufficiently shocked to quickly adopt Eurozone-wide banking standards and impose them? Will they include penalties and losses where necessary? Can they achieve a system-wide deposit insurance structure along the lines of the Federal Deposit Insurance Corporation (FDIC)? Is it possible to develop a process by which the ECB’s authority in regulation and supervision can function and a credible zone-wide banking system be implemented? Will the ECB reinstate collateral standards and adhere to them? Emergency Liquidity Assistance (ELA) is a proper vehicle only for the resolution of short-term problems. It led to Greece’s downfall, because it allowed the substitution of unsuitable for suitable collateral. It thereby fed money to deteriorating credits.

These and a hundred other issues have become urgent. Therefore, they require actions that will produce results acceptable to markets, investors, bankers, observers, academics, and journalists, all of whom are monitoring these events intensely.

And the actions must be believed and accepted by the general populace and the active business person. This sentiment issue has become critical. My sense from recent travel in Europe and the Emirates is that the general European population has given up on its leaders. Europeans feel powerless.

My sense also sees a Europe looking for believable answers. If positive action happens quickly, the euro can experience renewal. But it must happen quickly.

A bungled effort by the Eurozone finance ministers has resulted in a catastrophe of larger, uninsured deposit failure, threatened breach of smaller deposit insurance, and, now, capital controls. Capital controls are a desperate act and represent failed governance. They are the last twitch of a dying animal. Cyprus now has them.

Cyprus will suffer through an economic depression as it joins Greece and others in a downward spiral. Nothing good can come out of the recent events if the finance ministers remain in “business as usual” mode. Political statements in the Eurozone are falling on disbelieving ears. When an official says that everything is safe, he prompts additional runs on his banks. When someone says his government can honor its obligations, no one believes him. At this point, political silence is more credible than affirmative statements.

We have traveled the last two weeks in Europe and the Persian Gulf. Our discussions occurred in the midst of the Cyprus and Euro-system crises. We have held those conversations with professionals from as far north as Finland and as far south as Abu Dhabi. We have witnessed and discussed transfers in the billions. We viewed the manner in which they are occurring. We watched the surreptitious bleeding of balances from troubled banks, and we read the reports of individuals, businesses, and other agents performing an end run around the Eurozone finance ministers.

Euro sickness is coming to a head. Capital controls are the death of a country, currency, and economy. They create depressions. They are not temporary in the true meaning of a short-term action. Iceland still has capital controls five years after its banking shock. Nearly all countries in Europe are suffering a spiraling down of their financial structures. The 17-member Eurozone’s overall growth rate in 2013 will be near zero. The 27-member European Union will not be much better.

Europe’s leaders face a fundamental question regarding the euro. Do they want a requiem, in which case all they have to do is keep doing what they are doing, or do they want a renewal, in which case behavior must change credibly, immediately and decisively?

We are going to find out soon enough. Markets will force the requiem if political forces do not deliver the renewal.

For investors, this has become an easy decision. You can either bet on the renewal, which we are not ready to do, or you can bet on the requiem, which means capital moves out of the Eurozone.

We are underweight in Europe for very good reason. We are emphasizing investment strategies that seek some safety and resilience in a very dangerous, event-driven world.

We’re back in Sarasota. It is supposed to be 75 today, sunny and clear skies. It is Easter weekend and Passover. It is a time for celebration of freedom and resurrection. Both are needed for renewal.

Have a good weekend.

David R. Kotok, Chairman and Chief Investment Officer

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GIC in Dubai

Report from Dubai
March 24, 2013

From my friend David:



Looking at the world’s tallest building, the Burj Khalifa in Dubai, I thought of Brunelleschi and the construction of the dome of the Cathedral of Santa Maria del Fiore (the Duomo) in Florence.


Centuries ago, Filippo Brunelleschi, the Italian Renaissance architect, redesigned scaffolding so that his workers could have sanitary facilities and eat 180 feet above the ground. By enabling workers to remain above ground instead of spending their time climbing up and down, Brunelleschi increased productivity and thereby cut the construction time required to complete the dome in half with his genius idea. While the construction of the entire cathedral in Florence required 130 years, Brunelleschi’s work on the dome, begun in 1420, was completed by 1436 – a mere 16 years.


The construction of the Burj Khalifa started in January 2004 and was completed in January 2010. The entire building was finished in less time than Brunelleschi’s crew needed to build their scaffolding. We are about to visit the Burj Khalifa.


Dubai is a place of great contrasts that are immediate, robust, and continuously encountered. Here I am in the Persian Gulf and in the world’s tallest building, having had the good fortune to escape another of the world’s tallest buildings more than a decade ago, on September 11. Digesting these contrasts is a very intense and emotional experience.


Arriving at 1:00 a.m. at the world’s tallest hotel, the new JW Marriott Marquis in Dubai, one is greeted with long-legged, short-skirted women on their way to night clubs, but one shares the elevator with a burqa-clad mother and her children. In the same group are four young women from Saudi Arabia who have come to Dubai on holiday. They are bubbling with excitement because they have transitioned from one culture to another and want to experience the freedom and international collegiality of Dubai.


At the JW Marriott Marquis in Dubai, employees represent 71 nations. The hotel is an incredible assemblage of restaurants, luxurious accommodations, and services; it is one of the newest marvels in a city with incredible construction underway.


In neighboring Saudi Arabia, by contrast, life is austere. There are no cinemas, alcohol, or joyful exhibitions in any public place. It is hard to imagine that, an hour and half away in Dubai, the shopping malls are jammed with people from around the world. The tourism here is as intense and diverse as one might expect in Shanghai, Paris, or New York.


It is an exciting time to watch new buildings surging toward the sky, and to reflect on huge accumulations of affluence coalescing into one monumental edifice after another. That is the prospect that greets the eye in Dubai.


I was able to capture some fascinating images while here in Dubai. The first is a view of the city from the observation deck of the Burj Khalifa. The second is a view from the same deck looking upward to the top of the building. And the third image is of the famous hotel Burj Al Arab. Those images can be found on Cumberland’s website. Here are the links: http://www.cumber.com/content/special/IMG00190-20130323-0729.jpg, http://www.cumber.com/content/special/IMG00191-20130323-0732.jpg, http://www.cumber.com/content/special/IMG00198-20130324-0427.jpg.


Now to Cyprus.


We are sitting in Dubai with folks from around the world who are gathering for the Global Interdependence Center conference. It has been a fascinating day. I have toured the tallest building in the world and am relaxing in front of the tallest hotel in the world, enjoying the breeze and watching the sun set in the Persian Gulf. Cyprus is the focus of conversation everywhere.


Some things are becoming obvious as the events churn to a conclusion. Here are some points shared from economists, bankers, investors, and academics who are participating in this global meeting.


One: It is fairly clear to the political leadership in Europe that they goofed badly with their initial proposal. To be blunt, they blew it. Also clear is that they have learned not to attack the €100,000 baseline deposit insurance scheme.


Two: The best columns on Cyprus this weekend, both in the Financial Times (FT), were by John Authers, who discussed the meaning of the crisis in terms of markets, and Tony Barber, who discussed it in terms of history, setting, and geopolitical risk. We advise that the rest of the FT material that was devoted to Cyprus be mandatory reading for anyone interested in the subject and its impact on the world economy and financial markets.


Three: If you do not have the voters and legislature on your side, you lose. That was clearly the case among the Eurogroup, primarily dominated by finance ministers and politicians who ignored their respective electorates or at least some of them. That was clearly the case in Cyprus.


Four: The discipline of the European Central Bank needs to be applauded. The bankers realized that the deposit tax would trigger runs, but they could not make themselves heard by the politicians and finance ministers. Their warnings were unheeded to the extent that they were able to make the argument. Bankers understand that when you promise deposit guarantees to constituent citizens, you must always deliver on them. They realize you cannot violate that promise.


In a way, the Cyprus affair offers the opportunity for the Eurozone to advance more quickly. Serious central bankers and bank regulators know there must be some form of Eurozone-wide deposit insurance mechanism. They want to model it after the Federal Deposit Insurance Corporation (FDIC) that we have in the US. They now know that they have to do this quickly and that it must be credible.


Events will unfold in and beyond Cyprus; and as they do, the ramifications of these developments in the last several weeks will continue to become apparent. The actions of the finance ministers have changed the rules. They offered the notion that they would contemplate the unthinkable and attempt to impose it. They were rebuffed by the political forces that represent the smaller savers and the governmental body that had to either approve the plan at its own peril or reject it. Now we are going to see the rest of this tragic theatre unfold.


We will close with an excellent summary by Don Rissmiller of Strategas, whose firm is a participant in our conference here in Dubai. Don wrote: “A key question remains how big a ‘tax’ Cyprus will need – and from where – to secure additional funds. For any economy, there are generally 3 things that could be taxed: 1) income (what the economy generates this year), 2) wealth (what the economy has accumulated up to this year), and 3) transactions (as individuals exchange income and wealth). Income taxes and transaction taxes (sales taxes, VATs, etc) can come from this year’s pay. The problem for Cyprus is that – with a banking sector much bigger than GDP – there’s not enough income.


“And so, by eliminating all other options, the one that’s left has to be the answer. The question is, can Cyprus come up with a wealth tax that the population is willing to pay? And does that tax also avoid a dangerous precedent & euro-area bank runs? As we have noted before, making cash unsafe can have dire consequences – the economy needs a liquid asset in which to transact financial and (perhaps even more importantly) non-financial business.”



David R. Kotok, Chairman and Chief Investment Officer


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Fed Policy

Shared by my friend David Kotok as usual.  Thank you, David.

The New Fed Policy
March 21, 2013

Bob Eisenbeis is Cumberland’s Vice Chairman & Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com.  He may be reached at Bob.Eisenbeis@cumber.com.


While much has been written about yesterday’s FOMC decision and Chairman Bernanke’s press conference, some important points have been missed that may shed new light on the state of the Committee’s current thinking about its asset purchase program and how it is likely to be managed. In particular, the Chairman suggested that the Committee might adjust the pace of its asset purchases to its perception of the state of the economy rather than simply terminating the program abruptly. Indeed, he indicated that even if purchases were scaled back, the Committee wouldn’t hesitate to increase them again if conditions warranted.


The press pushed the Chairman on two points. What would the Committee have to see to change its program? Why didn’t the Committee provide guidance about changes in the pace of its asset purchase program, the way it did for its current policy accommodation? The answers and their lack of specificity were enlightening. First, consider the fact that the Committee reaffirmed its present policy accommodation in the face of an improving economy and four months of job growth topping 200K per month. The inference is that what we have seen didn’t exceed the Committee’s threshold criteria to change its asset purchase program. So how much improvement would be enough? The Chairman bobbed and weaved on this point, referring to the need for evidence of “sustained” improvement in labor markets.  But when pressed about what “sustained” meant, he indicated that the Committee would look at many factors, all unspecified. So on this first question, we now know less than we thought we did before.


The Chairman’s response to the guidance question was equally uninformative. He indicated that there was considerable disagreement among participants about the impacts that the QE programs were having, which made it difficult to set quantitative guideposts at this time. In other words, “We know it is working, we just can’t precisely quantify its impacts.” Given the state of the Committee’s knowledge about the quantitative impacts of its asset purchase program, it is understandable that it would be doubly hard to ascertain the likely impact of a slight modification in the asset purchase program, to a level of, say, $40 billion per month as opposed to either $30 billion or $50 billion. In economist-speak, the Committee has no idea what the impact multipliers look like.


So where does this leave us? Unfortunately, we now know less than we did before, because we don’t know what criteria will be employed to adjust the asset program or by how much it will be adjusted. Moreover, given the Committee’s indication that now the program may not only be extended but also incrementally adjusted up or down, projections about the ending of the program and the timing of the exit from policy accommodation are now less certain. Finally, while the incremental adjustments in additional purchases were discussed, the same kinds of considerations also apply to incremental asset sales from the program once a reversal in policy begins.


The whole discussion yesterday is reminiscent of Justice Potter Stewart’s famous conclusion when wrestling with the problem of defining obscenity. While he stated he couldn’t define it, he noted, “I know it when I see it.” After reflecting on Chairman Bernanke’s discussion of the FOMC’s current thinking on the pace of asset purchases, I think Justice Potter’s statement is an apt description of what we learned yesterday as well. They can’t define when it will be time to act, but they will know it when they see it.



Bob Eisenbeis, Vice Chairman & Chief Monetary Economist



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Stability Levy?

More from David Kotok:

Report from Paris – 2
March 20, 2013 (4:00pm, Paris)



“Just 20 months ago the three largest banks in Cyprus passed the European ‘stress tests’ with flying colors,” reports Ron DeLegge of ETFguide.  The latest estimates are 16 billion euros needed, and that number is rising daily. This will get worse.


When we planned this trip to Paris and Dubai, we had no idea that the Eurogroup would launch an unprecedented attack on bank depositors, banks, central banks, and the banking system of the entire Eurozone. But they did.


We boarded flights from Sarasota to New York and then to Paris as the news unfolded regarding the “tax,” called a “stability levy,” on depositors in Cypriot banks. Depositors of €100,000 or less were to have a levy of 6.7 percent confiscated from their bank deposits. Above €100,000, it was to be 9.9 percent.


The proposal triggered an uproar and runs on ATMs, and then it fizzled in the Cypriot parliament as a result of the public outcry. The unfolding situation has been a mad scramble ever since. Issues, limits, amounts, back-up credit if there are runs, emergency liquidity provisions, small-saver exemptions, corruption reporting, preservation of national deposit guarantees, and a hundred other issues are being resolved.


Every one of the official commentaries characterized the response as a “one-off” event, declaring that this would not happen again and justifying this action as necessary in order to avoid an outcome certain to be even worse. During secret weekend meetings, the Eurogroup, finance ministers of the Eurozone, and other powerful leadership concluded that they could take portions of bank deposits from everybody – foreign or domestic, small or large – and confiscate them. They could confiscate them because of a crisis resulting from their own failure to supervise and regulate one of the member central banks that is part of the Eurosystem. They did that, and the consequences are going to be enormous.


We have reached our conclusions about the banking crisis now in the Eurozone following this action and following the previous action in which private-sector debt holders of Greek sovereign debt were essentially “screwed.”


Unless there are systemic changes for the better, you cannot trust a Eurosystem deposit in a Eurosystem bank in a Eurosystem country. Unless there are systemic changes, you cannot trust and depend on sovereign debt promises of a Eurozone country. Unless there are systemic changes, the Eurosystem, Eurozone debt, and Eurozone bank exposure now carry a risk premium of some amount. That risk will vary by country, bank, and structure. In every case, there is a premium.


In the case of countries whose policies and behaviors have been exemplary during the crisis, the premium will be quite small. Finland is a good example of a euro-system, Eurozone, and EU member country that continues to manage its monetary and economic affairs with complete credibility and reliability. We would expect no visible impact on Finnish banks, debt, and financial market structure.


Germany is the largest weight in the Eurozone. It is also operated in a disciplined fashion. We do not expect much impact there.


But the farther you go into the financially weaker peripheral countries in Europe, the worse the risk premium is going to get. Cyprus is one obvious case study; Greece is another.


The question is, what will the impacts be on marginal countries? Some are trying to improve the state of their economic affairs. Does the action in Cyprus make it harder for Portugal to turn around and improve? Is this a setback for Ireland? What happens in Spain, where the banking system is under stress and the economy under double stress? The political mess in Italy renders the questions huge.


When you consider the total debt and total size of the troubled countries in the Eurosystem and the Eurozone, you can reach only one conclusion. This system is sick. Its political leaders are making a crisis situation worse by making decisions that they claim to be single events, and without a pattern or overall policy approach. No one believes them anymore. No depositor who is capable of avoiding this exposure will seek the exposure. Instead, depositors will seek alternatives.


Taxation rates in some countries, such as France, are driving wealth and entrepreneurial spirit out of the country. In other places, political uncertainty is so high that it impairs any advancement in growth or economic recovery. For the entire Eurozone, we would expect in 2013 that the growth rate will be near zero.


Some of the unemployment characteristics in various countries have reached levels that have no precedent and are destabilizing. In some countries the unemployment rate among youth is over 50 percent. In most countries the unemployment rate is measurable in double digits.


Europe’s leaders, in our view, continue to make bad decisions. In doing so, they make bad matters worse.


We have not reached this painful conclusion without careful research. We have had a series of meetings in Paris with money managers, central bankers, investors, and academics. All of our meetings here were private. In the candor of those private discussions, we come away with the most troubled view we have had of the Eurozone, the experiment in this single-currency block, and the market structures in Europe. This is a place in trouble. Courses of action that evidence more flailing than forethought are not making things any better.


We will soon leave for Dubai for the Global Interdependence Center event, the latest in the GIC Banking Series, this time focused on challenges and opportunities in the Middle East. Our comments on March 26, 2013, will subsequently be posted on Cumberland’s website along with our slides. Interested readers will be able to track this at www.cumber.com.


For investors, we would strongly recommend that careful consideration be given to exposures in the Eurozone, the Eurosystem, the European Economic Community, and the European Union. Things have changed. Watch closely for bank runs. Also watch use of Emergency Liquidity Assistance (ELA), and watch how the European Central Bank (ECB) reviews value of collateral. Lastly, watch out for new capital controls in Cyprus. They will signal a death knell for cross-border money flows.



David R. Kotok, Chairman and Chief Investment Officer


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Cypriot banks

By David Kotok

Report from Paris
March 18, 2013



Several world travelers are sitting at lunch in Paris, immersed in speculation. Greek banks in Cyprus were ring-fenced. Cypriot banks were not. Why?


If Greek banks with branches in Cyprus are punished, the euro group has to offer more money to bail them out. So why magnify the loss by including the Greek banks’ branches in Cyprus? Next, think of the geography here. Cyprus is divided: half its people are Turkish and half are Greek. There is ancient enmity at work here. Why exacerbate that?


Now get to the issue of Turkey. Turkey has been baited about the European Union for decades. It is neither in nor out. Some premiers such as former French presidents say things like, “Someday they will qualify.”


Look at Turkey’s shared borders with countries like Syria, Iran, and Iraq. Think of what the world looks like today. Think of Turkey as a very strong growth emerging market.


If you had to handle a banking crisis involving substantial Russian deposits in the European Union and Eurozone and denominated in the euro, what construction would you use?


Now we are in the throes of this mess in Europe. No one knows how this will turn out. Add to that the prospect of Russian retaliation. Does it come in the form of higher energy prices? Does it come with taxation or imposition of fees on the electrical grid that runs through Eastern Europe? No one knows.


The decision to impose taxation and revise the formula in order to maintain parliamentary passage, thus enabling the Russians to pay the price, is fraught with risk.

We expect large bank runs, and not only from Cypriot banks. No one in their right mind would hold euro deposits in weaker banks or weaker countries. Cyprus is proof that national deposit guarantees are worthless in the present euro-system structure.


It is Paris and it is cold. Lunch and the conversation are exciting.


David R. Kotok, Chairman and Chief Investment Officer


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On Eurozone Investments


Shared by my friend David Kotok:

Are There Investment Opportunities in Europe?
March 14, 2013



This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist.  He joined Cumberland after years of experience at the OECD in Paris.  His bio is found on Cumberland’s home page, www.cumber.com.  He can be reached at Bill.Witherell@cumber.com.



The eurozone is expected to remain in recession, recovering slowly in the second half of this year. The European Central Bank (ECB) recently revised downward its GDP forecast for the year to -0.5%. One may reasonably question the wisdom of investing in any of the eurozone national equity markets this year. We believe there are, nevertheless, some attractive investment opportunities in this region, for two main reasons.


The first reason is that there is surprisingly very little correlation on a year-to-year basis between GDP growth and stocks, even in terms of direction. Analyses by our friends at Ned Davis Research have demonstrated this. The lack of correlation is particularly evident in Europe. Last year, while GDP growth in Germany slowed from 3.1% the previous year to 0.9%, and slowed in France from 1.7% to 0%, the ETF that tracks that tracks the German equity market, iShares MSCI Germany (EWG), gained 32.8%, and the French ETF, iShares MSCI France (EWQ), gained 24.4%. One reason is that the stock market usually leads the economy. By the time GDP figures are released and then often significantly revised, the underlying data is well-known and largely factored into the market. Leading economic indicators are generally better predictors of market developments.


Also, European stocks are strongly affected by financial developments. European firms depend on banks for 80% of their debt financing needs. Any indication that credit conditions will tighten quickly impacts equity prices. Last year, when ECB President Mario Draghi stated the central bank would do “whatever it takes” to protect the euro, support the eurozone’s financial system, and keep credit flowing, the subsequent “relief rally” more than offset concerns about the slowing economies in the region. Investors remain optimistic that the tail risk of a major financial crisis in Europe has been greatly reduced. Even the results of the Italian election, which implied a rejection of economic reform and austerity policies, were taken in stride by financial markets after an initial sharp downward jolt, to Italian equities in particular. Bond spreads versus Germany’s remain well below those of 2012.


The second and more important consideration in deciding whether to invest in Europe is that there are great differences among the eurozone economies and equity markets. The largest eurozone country, Germany, is clearly doing better than its neighbors. While foreign demand has been weak in the region, export growth to emerging markets has been healthy. Germany’s competitiveness has so far permitted it to overcome the headwind of the strong euro in recent months. Its fiscal accounts are in balance, in contrast to the situation for most advanced economies. Incomes and household consumption are rising, and low interest rates are stimulating residential construction. Germany also benefits from being considered a safe haven by investors. Germany’s equity market is our first choice within the eurozone. The German ETF, EWG, has just about recovered from a drawback, shared by most eurozone markets, that was prompted by the Italian elections. It has gained 2.47% year-to-date.


While the French equity market’s performance thus far this year has been very close to that of Germany, the two economies appear to be diverging as French President Hollande struggles with growing signs of a very significant real estate bubble, disturbingly high unemployment, fiscal imbalances that severely limit the government’s scope for stimulating the economy, and strong resistance on the part of his supporters, in particular the trade unions, to needed economic reforms. The OECD’s leading indicators and the latest PMI (Purchasing Managers Index) readings point to France’s relative weakness. France’s industrial production dropped by 1.2% in January. A period of underperforming equities looks likely.


Italy and Spain are the third and fourth largest economies in the eurozone. Both economies are depressed, with Italy’s GDP some 10% below its pre-crisis levels. Both countries have enacted significant and much-needed economic reforms. In the case of Spain the PMI increased significantly in February, from 48.1 to 58.6, and industrial production ticked up in January by +0.6% over the previous month. Spain’s economy does appear to be turning the corner, while Italy’s recovery is less clear so far. Its PMI declined in February from 47.8 to 45.8. Its industrial production for January is not yet available. Both economies have had to face a stronger euro in the opening months of this year, which has had the effect of offsetting the improvements in competitiveness they had achieved. Going forward, their ability to progress will depend on the future course of the euro, since the opportunities for further competitiveness-enhancing reforms appear limited by the political situations in both countries.


Spain’s equity market has recovered strongly from its August 2012 lows, and year-to-date the Spanish ETF, iShares EWP, is up 2%. It is likely to do a little better than the eurozone average this year. Italy is a more risky call due to the unsettled political situation. Italy’s equities experienced a strong sell-off in February as a result of the elections, dropping by 12%; and they are still down by 6.8 % year-to-date, as measured by the iShares MSCI Italy ETF, EWI.


The unresolved government situation in Italy is indeed a mess. Whatever government emerges, further economic reform initiatives seem unlikely, at least in the near future. But the agenda has already been set by the outgoing Monti government, and many reforms have been established as laws. Some easing of austerity measures is likely and probably would be good for the market. We should remember that Italy has a history of weak governments and profligate fiscal policies. Its economy has lagged those of other European countries. Still, there are some positives for Italy. With the exception of 2009 and 2010, the Italian government has run primary surpluses (that is, excluding interest payments). Neither Spain nor France can claim the same. Italy’s private sector carries relatively little debt and has a high net worth. Italian banks are in a stronger position than those in many other eurozone countries. It was the public sector’s heavy indebtedness, along with financial contagion, that caused investors to pull out of Italian equities during the eurozone financial crisis. With Italian equities very cheap and still near multi-year lows, we see the possibility of their outperforming the German, French, and Dutch markets over the next 12 months as the economy recovers.


The strongest recent performance by a eurozone equity market has been that of Ireland, gaining 34.3% last year and already up 10.9% this year. Ireland returned successfully to the bond market today, drawing at least 12 billion euros of bids for its 10-year bond. This is an important milestone marking its impressive recovery from the bailout in 2010. We have only two hesitations now about taking a position in Ireland. The first is to question whether, after the large run-up to date, the rally in Irish stocks might be due for a pause or even a correction. The second is the relatively small market capitalization of the Irish ETF, the iShares Ireland Capped Investible (EIRL), which has a liquidity ranking by Ned Davis Research of only 2 out of a possible 5. This limited size is understandable for the equity market of an economy that constitutes only 1.8% of the eurozone economy, but limited liquidity is a drawback for our firm.


There are options for investors who would rather not try to decide which of the eurozone markets is most likely to outperform. The highly liquid iShares MSCI EMU Index ETF, EZU, tracks the MSCI EMU index that covers all countries in the European Monetary Union. It is up just 1.55% year-to-date. There is another interesting, but also limited, liquidity option, the WisdomTree Europe Hedged ETF, HEDJ. This ETF invests in eurozone equities of companies “with significant revenue from exports” and is hedged against changes in the euro/US dollar exchange rate. If the euro were to decline relative to the dollar, as some are predicting, this ETF should perform better than an equivalent unhedged investment. It has a lower concentration in the financial sector than EZU, only 8.27% versus 20.74%. HEDJ is up 5.58% year-to-date.


Finally, we note that the European markets we continue to favor outside of the eurozone are Sweden and Switzerland. The iShares Sweden ETF, EWD, is up 9.9% year-to-date following a 24.57% gain in 2012. The iShares MSCI Switzerland ETF, EWL, is up 9.44% year-to-date following a 21.85% gain in 2012. We remain negative on the United Kingdom, where the economy appears to be dipping back into recession. The iShares MSCI UK ETF, EWU, is only marginally positive this year, +0.67%, after gaining a respectable 15.33% last year.



Bill Witherell, Chief Global Economist



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2012 @ GIC in Review

Members of the Global Interdependence Center:

I am delighted to provide you with the 2012 Global Interdependence Center Year in Review. Last year saw many firsts for GIC – including the first Global Society of Fellows meeting and the first GIC event in Ghana. From in-person events to a new online presence, GIC connected members with fellow high-profile industry leaders and respected academics in the world of international finance and economics throughout the year.

We have continued this work in 2013, already hosting three successful GIC events. I look forward to the coming five months, during which GIC will host events in Dubai and Abu Dhabi, Sarasota, Richmond, Philadelphia, Milan and Jackson Hole. I hope to see you at one or all of these events.

Best regards,

Ben Craig
Executive Director

After decades on the campus of the University of Pennsylvania, GIC moved across the Schuylkill River to the Federal Reserve Bank of Philadelphia in 2012. Now located near the Constitution Center and the U.S. Mint, GIC’s new location is at the very heart of law, finance and monetary policy in Philadelphia.


GIC’s updated website launched in the beginning of 2012. Offering papers, videos and presentations, the GIC website enables visitors to relive GIC events and dig deeper into international finance.
In addition to the website, you can connect with GIC online through several other platforms. Like GIC and the Global Society of Fellows (GSF) on Facebook, follow GIC and GSF on Twitter, subscribe to GIC and GSF on YouTube, and join GIC’s exclusive, members-only group on LinkedIn!


Founded in 2010, the Global Society of Fellows held its inaugural meeting in Paris. Hosted by the Banque de France, the meeting inducted the Society’s first class of fellows: Paul McCulley and John Silvia.
The second annual meeting of the Global Society of Fellows will take place on April 9, 2013, in Richmond, Va.


Hosting 14 events in cities across the globe, GIC brought the top thought-leaders in international finance to members and friends of GIC. Event locations included Accra, Buenos Aires, Jackson Hole, Memphis, Philadelphia, Sarasota, Tokyo and Warsaw. Below are some of the highlights from our 2012 events:

Food and Inflation: Truth and Consequences
February 8, 2012 | Memphis, Tenn.

View presentations by:
Michael Bryan of the Federal Reserve Bank of Atlanta
C. Bailey Ragan of Bunge North America
Randall W. Powell of BioDimensions, Inc.
Kevin Kliesen of the Federal Reserve Bank of St. Louis
Dan Halstrom of US Meat Export Federation
Harold Reed of The Andersons, Inc.
Daniel Basse of AgResource Company
David Altig of the Federal Reserve Bank of Atlanta

Debt Rating Agencies:
Their Role in the Global Capital Markets – Past, Present and Future

February 29, 2012 | Philadelphia, Pa.

Read press coverage of the event:
“Your Money” in the Philadelphia Inquirer

Housing: What’s Next
April 18, 2012 | Sarasota, Fl.

Read press coverage of the event:
“National Housing Experts Debate Market Conditions in Manatee” in the Bradenton Herald
“Experts Agree: Housing Crisis Has a Light at the End of the Tunnel” in the Sarasota Patch

Economies of Baltic Sea Regions and their Capital Markets:
A Sustainable Recovery?

May 23 – 27 | Warsaw, Poland

View presentations by:
Maciej Stanczuk of PBP Bank
Cezary Wojcik of the Polish Academy of Sciences and the
Warsaw School of Economics

Fourth Annual Rocky Mountain Summit
July 27, 2012 | Jackson Hole, Wy.

Read press coverage of the event:
“Expert: U.S. to Export Liquefied Natural Gas by 2016” in IndustryWeek
“The Buzz at the Rocky Mountain Summit” on BloombergTV
“On the Road in Jackson Hole: Not Bullish on GDP” in Politico

Proving a Sustainable Model for Permanent, Primary Healthcare Infrastructure in Ghana and Other Developing Nations
September 12-14, 2012 | Accra, Ghana

View presentations by:
Sanford Health
Felix Osei-Sarpong of USAID
Dana Allison of Women’s World Health Initiative

The Global Financial Crisis: Lessons from Japan

December 1 – 4, 2012 | Tokyo, Japan

Read GIC’s event review.

View presentations by:
Tadao Yanase of Japan’s Ministry of Economy
Yoichi Takita of Nikkei
Kozo Koide of DIAM Co. Ltd.
Manuel Balmaseda of CEMEX
John Silvia of Wells Fargo

GIC has an exciting line-up of events slated for 2013. Visit the GIC website to learn more.