It's time to sell the euro
By
Associate Editor
David Stevenson
Aug 07, 2008
We’ve been more than a little downbeat on the outlook for most ‘developed’ economies for a good while now. So it’s been no great surprise to see that the rest of the financial pundits are finally coming round to the idea that the global economy is heading for trouble.
But while there seems to have been more or less a straight fight between the States and us as to who actually plunges into a recession first, within the last few weeks another strong contender for this dubious prize has emerged. The eurozone now looks like it could get a dose of recession before either the US or the UK.
That means the euro could well be about to fall off its perch and join the ever-lengthening list of the world’s ill currencies. That’d be good news for the dollar - and maybe even the pound
Why the eurozone could beat the UK to recession
Anyone who has been keeping an eye on Spain’s troubled economy won’t be too surprised to see that the eurozone is really struggling. The Hispanic housing market is collapsing – sales are down 34% from the peak, say the latest official figures – and the banking system is on the brink, according to Morgan Stanley.
“A momentous economic slowdown in Spain is now under way… though just in the beginning stages, with the bulk of the pain to be suffered in 2009”, says the investment bank, going on to warn that “the probability of a crisis scenario similar to the early 1990s is increasing”.
Meanwhile unemployment has already reached 10.4% and the country’s finance minister recently admitted that: “the economic situation is worse than we all predicted… we thought it would happen slowly but it has hit fast”.
It’s not just Spain. In Ireland too, house prices are tumbling, with Dublin seeing double-digit falls. New housebuilding has hit a five-year low. And over in Italy, things aren’t so hot on the economic front either. Last weekend Prime Minister Berlusconi said he would now be slashing government spending as tax revenues have slumped.
But let’s be fair here. Trouble in these countries isn’t exactly a surprise – Ireland was heading for trouble from the moment it joined the eurozone, as low interest rates poured petrol on an already blazing economy. Spain was the same. And as for Italy, it’s rarely far from economic strife.
Surely the countries at the real core of the eurozone - France and Germany, in other words – are looking a bit more stable? Well, it seems not. After holding out pretty well during the first half, by mid-July, business confidence was declining abruptly, as the German ZEW economic sentiment indicator suddenly plunged, unexpectedly, to a record low. French business confidence has also dropped away.
Then last week, the overall eurozone activity survey plummeted much more sharply than the ‘experts’ had expected, to its lowest point since March 2003.
What’s more, European companies are starting to default on their debts, says Dresdner Kleinwort, which believes that as many as 6-7% of corporate borrowers may fail to pay their debts on time within the next year. That’s a tenfold increase in the estimate since June and, says Moody’s Investors Service, the highest default rate since July 2003. Add in Tuesday’s 0.6% drop in retail sales for the region, and the picture we’re seeing emerge isn’t at all pretty. Because things have got worse so fast that the eurozone now looks like a racing certainty to beat us Brits into recession.
The euro's problems are good news for the dollar
It all points to a sell-off in the euro. Sure, the alternatives may not be great, with both the US and the UK apparently competing to see which can prove the bigger basket case, but to quote one of the oldest market truisms around, currencies are a ‘zero sum’ game.
If one falls, another has to rise. And while it’s very hard to make a convincing case for the dollar, or indeed the pound, all the signs from the continent are that the euro faces even more problems.
Pimco bond fund manager Bill Gross recently said he sees no reason for "the euro's 25% to 30% overvaluation against the US dollar", while BNP Paribas also declared: "we're turning incredibly bearish on the euro." It’s starting to feel like the dollar, currently trading at around $1.55 to the euro, might just be bottoming out against its continental European cousin. And maybe sterling, which over the last five years has tended to move more or less in line with the buck, could get a ride on its coat tails.
That’s all very interesting for currency traders – and if you want to know more about how to play currencies, see: How to play the currency markets.
However, with the eurozone in trouble too, it’s looking ever harder for investors to find decent stocks to invest in. But one man who thinks he has the answer is Stephen Bland. You’ll be getting an email on his investment strategy – which he reckons is a long-term winner, regardless of what’s happening in the markets – later today. Look out for it.
Turning to the wider markets…
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UK shares headed higher as merger fever took hold in the mining sector, after Xstrata’s hostile bid for platinum group Lonmin. Xstrata is offering £33.00 a share, but Evolution Securities said it reckons that £40.00 would be a fairer price, and the market agreed, sending Lonmin’s share price above the offer to close at £34.26. Broadcaster ITV slipped back after reporting a first-half loss of £1.54bn. The FTSE 100 rose 31 points to 5,486.
Shares in Europe were also higher. The Xetra Dax gained 0.65% to 6,561, with Adidas the main riser as second-quarter results pleased the market. In Paris, the CAC 40 put on 1.4% to 4,448.
Over in the USA, lower oil and a stronger dollar helped push stocks higher. The Dow Jones Industrial Average climbed 40 points, or 0.4%, to 11,656, while the wider S&P 500 rose by 0.3% to 1,289 and the tech-heavy Nasdaq Composite gained 1.2% to 2,379.
Overnight the Japanese market fell 1.0%, 129 points, to 13,124. Banks were among the main fallers as Chuo Mitsui Trust Holdings, the country’s 11th-largest bank, saw first-quarter net income plunge 52% with bad debt costs more than doubling.
This morning commodities were mixed, with Brent spot trading a little higher at $116.85, spot gold at $883, silver at $16.63 and platinum at $1,593.
In the forex markets this morning, sterling was trading against the US dollar at 1.9502 and against the euro at 1.2607. The dollar was trading at 0.6466 against the euro and 109.43 against the Japanese yen.
In London this morning, Barclays has reported a 34% fall in earnings for the first-half. Profits of £1.72bn were above City hopes, but the £2.8bn in credit-related write-downs was worse than the £2.3bn expected. The bank repeated that it plans to pay an 11.5p cash dividend for the first half, the same as last year. Our recommended article for today...
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David Stevenson
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