By
Cam Hui
:
In this week's essay, John Mauldin
characterized
France as the "lion in the grass". He began with the comment that
there are certainly lots of risks (lions) in Europe:
We can all see the lions, large and small, of Greece,
Portugal, Ireland, Spain, Italy, and now Cypress and Malta. The
fear of contagion is what keeps European leaders up at night,
trying to figure out how to keep Spain afloat. Because if Spain
sinks, the focus immediately turns to Italy.
The hidden risk is in France, Mauldin wrote:
But enough of the lions we can see. Don't look now, but the
lion that lies hidden in the grass is France. Yes, the France
that is supposedly a big part of the solution to eurozone woes
and Germany's stalwart partner in guaranteeing all that debt. AAA
France. Rated that way by the same people who turned the nuclear
waste of subprime CDO squareds, composed 100% of the worst sort
of BBB junk, into gold.
Now, the rating agencies are using the same alchemical
Philosopher's Stone to transmute French debt into … fool's
gold.
Today, investors are lending to the French state for five years
for less than 1%
and its
10-year yields are at all-time lows
, presumably it has been lumped in with the likes of Germany as
being a safe haven, the French fiscal outlook is dire. In
particular, he pointed to an IMF study (actually, I believe that it
was a BIS working paper called
The future of public debt: prospects and
implications
). The study examined the debt to GDP path of various major
industrialized countries and Mauldin observed that the French debt
trajectory look the most like Greece.
Click to enlarge:
|
|
BIS Public Debt to GDP projections
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Yes, the country most like France is Greece. Yes, THAT Greece.
The one that just defaulted. The one that everyone agrees is
dysfunctional. Also notice that if Greece were to follow the
suggested draconian path, it could stabilize its debt. And then
notice that if France were to make the same level of draconian
cuts, its debt-to-GDP ratio would merely rise to almost 200% within
25 years. Oops.
Two reactions
I have two reactions to that analysis. My inner investor says,
wow that's terrible. France is an accident waiting to happen.
French debt costs will surely blow up and investors need to
re-examine the credit risks of any debt paper that they consider.
If French yields were to surge because of some event, then risk
premiums will also blow sky high and that won't be good at all for
the risk-on trade, i.e. stocks, commodities, etc.
My inner trader tells me that, under the current circumstances,
French real interest rates are negative and that
France is actually making a profit by running these
deficits
. It has zero incentive given market conditions to rein in its
deficits. In fact, it should be taking advantage of current
conditions to extend the maturity of its debt structure in order to
lock in low rates.
It's important to be aware of the long-term risks of the French
fiscal path, these kinds of things have a way of not mattering to
the market until it matters. As a trader who is measured by the
bottom line in his portfolio, he has to be aware of the risk but
not hide in the bunker and act on this "lion in the grass" until
the lions starts to move. You have to watch for the inflection
point.
These differing viewpoints certainly put the Merkel/austerity
vs. Hollande/stimulus debate into a fresh perspective.
Disclaimer
: Cam Hui is a portfolio manager at Qwest Investment Fund
Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as
an outside business activity. As such, Qwest does not review or
approve materials presented herein. The opinions and any
recommendations expressed in this blog are those of the author and
do not reflect the opinions or recommendations of Qwest.
None of the information or opinions expressed in this blog
constitutes a solicitation for the purchase or sale of any security
or other instrument. Nothing in this article constitutes investment
advice and any recommendations that may be contained herein have
not been based upon a consideration of the investment objectives,
financial situation or particular needs of any specific recipient.
Any purchase or sale activity in any securities or other instrument
should be based upon your own analysis and conclusions. Past
performance is not indicative of future results. Either Qwest or
Mr. Hui may hold or control long or short positions in the
securities or instruments mentioned.
See also
E-Mini S&P 500: Pre-Fed Blues
on seekingalpha.com