Still Too Early to Consider Investing in the Eurozone

Tuesday, 02 Apr 2013 10:21 AM

By Hans Parisis

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While the first quarter of this year was interestingly eventful, the second quarter seems equally promising to be eventful as well. No, no time for complacency, although markets seem to be just that way. From my side, I’m not following that mood of the markets.

At this moment, markets don’t seem to be worrying about the continuous showing of provocation and bellicosity of North Korea. And with good reason. So far, at least, it all seems nothing more than a North Korean exercise in sable rattling while no troop mobilizations/movements have been observed.

Thus, we could say, so far so good. But as an investor, I think these events are certainly not of the kind that can be disregarded and certainly not now when, North Korea’s Korean Central News Agency (KCNA) news service reported the country will restart all nuclear operations at the country’s major nuclear facility at Yongbyon, which produced the fissile material for North Korea's nuclear weapon tests in 2006 and 2009. KCNA added these nuclear facilities would be used for both electricity and military uses. By the way, the reactor at Yongbyon was shut down in 2007 as part of an aid-for-disarmament deal.

I’m not saying all this will end up badly, but in my opinion there is no reason whatsoever not to ask ourselves, as investors, what could be the reaction of the markets on a worldwide scale if things took an “unexpected” turn for the worse on the Korean Peninsula for whatever still “unknown” reason. Yes, unfortunately here we have another worrisome case of a known unknown.

Please keep in mind the time horizon here stretches from the near future to easily a few years.

That said, the world appears being locked into mediocre growth with one very big exception, which is the United States.

On Monday, Markit Group released its final data for the U.S. March Manufacturing Purchasing Managers’ Index (PMI) that came in at 54.6, indicating overall business conditions continue to improve, while the average percentage for the first quarter came in at 54.9, which is the strongest showing in two years. Also job creation showed continuous sustained growth.

Also on Monday, the Institute for Supply Management (ISM) released its latest U.S. Manufacturing ISM Report On Business PMI, which came in at 51.3 (above 50 means expanding). This was below expectations, but that showed the overall U.S. economy grew for the 46th consecutive month. The employment index came in at 54.2, which is up from 52.6 in February and translates into a faster growing pace.

Nevertheless, as an investor, it would be wise not getting too overly optimistic because the United States probably could see gross domestic product growth at around 3 percent or even higher during the first quarter. But it will be absolutely necessary to sustain that kind of positive growth trend because we should expect the United States would have to face fiscal headwinds in the months ahead.

From its side, the HSBC China Manufacturing PMI for March came in at 51.6, which is up from 50.4 in February, and shows the Chinese manufacturing sector has now improved at a quiet pace for five consecutive months even though it continues to struggle with lingering external headwinds of which the strongest comes out of Europe. No, it’s nothing for getting excited about, especially when you keep in mind that a hard landing in China can’t be ruled out somewhere in the second half of 2014.

Taking into account what we know so far, my doubts about China are mainly associated to the fact we see relentless expanding state capitalism that’s getting even more and more deep rooted in its economy. You don’t have to be a rocket scientist to know that state capitalism and sound sustainable growth don’t go together. Yes, one day they’ll have to pay the piper.

In the European Union, we’ve seen a new edition (complicated and full of half-truths, as usual) of the eurozone debt crisis flaring up again. In my opinion, the ramifications of the Cypriot bail-in/bailout will be much further reaching and certainly far beyond what most investors and non-investors have in mind today.

Already, Philip Suttle, deputy managing director and chief economist at the Institute of International Finance (IIF), which is the world's only global association of financial institutions, said because of the recent and future struggles of Cyprus, there is a distinct possibility the country could exit from the European Monetary Union. Yes, the EU taboos are no more as sacred as they have been until now.

Believe me, the European Monetary Union, and especially the peripheral countries, is in deep trouble with no light whatsoever at the end of the tunnel yet.

The euro area unemployment in February reached a new record high of 12 percent, which was the same as in January after it was revised up from 11.9 percent, Eurostat reported. For comparison, the U.S. unemployment rate stood at 7.7 percent in February while in Japan it was at 4.2 percent in January.

Youth unemployment in the eurozone is now locked into some kind of a death spiral that is still expanding to horrendous levels, especially in the peripheral countries, of which the highest level has been noted in Greece (58.4 percent in December 2012), but also in Spain (55.7 percent), Portugal (38.2 percent) and Italy (37.8 percent).

Of all the European Union member states, only Germany (8.1 percent), Austria (8.7 percent) and the Netherlands (9.4 percent) had in February a youth unemployment rate below 10 percent. Talking of a ticking time bomb, this situation is certainly one for the records.

These extremely bad employment numbers were de facto confirmed by the final data of the Markit Group Eurozone Manufacturing PMI for March, which came in at 46.8, down from 47.9 in February, and where we see business conditions deteriorating in practically “all” euro member states with, albeit, only modestly declining in Germany (49), but on the contrary steep downturns took place in France (44), Spain (44.2) and Italy (44.5.)

No wonder emerging economies have been dumping euro reserves and euros now only represent 24 percent of their reserves, which is the lowest level since 2002 and down from the 31 percent peak we’ve seen in 2009.

The dollar has held steady as the world currency reserve, at slightly above 61 percent. The latest Currency Composition of Official Foreign Exchange Reserves (COFER) that is released by the International Monetary Fund showed total reserves stood at $6.08 trillion at the end of 2012, of which $3.76 trillion was in U.S. dollars and $1.46 trillion was in euros.

In my opinion, it’s still too early to consider investing in the eurozone. Please don’t worry. That time will come, but we aren’t there yet.

Long-term investors would do well by keeping it simple and keeping the United States as the main home for their investments in the foreseeable future. Keep in mind that I still expect a correction in the offing when we take into account the wave structures in the markets. Of course, I could be wrong, but anyway, that’s my personal view.

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