Europe has voted! Five key takeaways

Deutsche Bank say that the biggest surprise to come out of the European elections was perhaps the increased voter participation (largest in 25-years), which should be interpreted as as an indicator that Europe managed to mobilise its citizens after all, however, differences in turnout across the EU have been substantial, with particularly low participation rates among Eastern members and the UK, they note. In terms of the actual result, while there was no ”landslide” for the populists, there has been enough of a shift to upset the balance of power in the European Parliament. They highlight their 5-key takeaways from the election result. 1) The “grand coalition” of conservatives (EPP) and social democrats (S&D) has lost its traditional absolute majority in the next European Parliament. Together with the liberals and greens, pro-European groups will still hold a clear majority of two-thirds of the seats in the next EP. But policymaking for them will likely become more complex and require broader cross-party agreements and discipline. 2) With above 30% of seats, Eurosceptic and anti-establishment groups and (nonaligned) parties are estimated to have increased their weight in EU policy making over next five years. DB remain doubtful that these groups will manage to permanently overcome their (many) differences and use their leverage to promote their own coherent policy agenda. 3) Balance in the next EP will also depend on group formation over the next few weeks. Big questions remain, such as the planned joint group between the liberal ALDE and French President Macron’s Renaissance as well as the composition of Italian Deputy PM Matteo Salvini’s new far-right Eurosceptic alliance and the efforts of Five Star Movement to create a new (also Eurosceptic) anti-establishment group, potentially to be joined by Nigel Farage’s Brexit Party from the UK. 4) The increased fragmentation on the next EP will make the appointment of the next Commission President a potentially lengthy procedure. 5) A lengthy standoff between Council and Parliament as well as intense negotiations on the top jobs between leaders could push the appointment of the next Commission beyond October, and could thus impact market’s confidence and trust in the single currency.

Global automaker mega mergers not a panacea to industry challenges

Fiat, Chrysler, Jeep, Renault and Dacia all under one roof? The FCA-Renault merger plan (which would make it the world’s 3rd largest carmaker) follows persistent auto sector merger talk that coincides with slowing global demand and growing technological challenges, say Scope Ratings, yet is a new megamerger the right response? Scope Ratings are sceptical in their latest research note on the sector. There are two reasons for their scepticism: the limits to economies of scale and the difficulty of executing merger plans smoothly. Scope Ratings say that the auto industry is bracing itself for a downturn amid slowing economic growth worldwide following an extended cyclical recovery from the Global Financial Crisis, and this most recent deal is typical of merger deals that signal the business cycle is turning. Furthermore, the threat of an all-out trade war between the US and China, is another danger for the industry. With that as the backdrop, manufacturers realise that in order to fund the heavy investment in research and development required to develop new products such as electric vehicles, they are tempted to spread development and production costs over bigger businesses by volume, particularly when sales are in danger of shrinking. However, it is not quite as simple as that, say Scope. According to calculations of the US Department of Energy, the cost effects from scaling up battery cell production facilities are not as significant as one would expect, meaning the benefits of such mega mergers may be not as large as these companies expect. Scope believe that special partnerships and bolt-on acquisitions are more promising. BMW and Daimler, for instance, have created separate partnerships to pool investment in car sharing and autonomous driving based on earlier small acquisitions. At the same time, Volkswagen has teamed up with Ford to work on joint projects.

Trade: Sowing the seeds for a classic supply shock

It is hard to game the possible outcomes from the resumption of the trade wars, writes Phil Suttle from Suttle Economics. He admits to being too optimistic about a solution in earlier in the year, but is leery of turning pessimistic now. Logic dictates a negotiated outcome, possibly at the G-20 meeting in Osaka at the end of June. But….one never knows. This note therefore looks at what has actually happened to US-China trade flows and prices over recent months. Two important conclusions emerge, says Suttle. Firstly, trade flows have only recently begun to turn down, suggesting that protectionism took time to bite, but is now doing so with a vengeance. Secondly, price data suggest that the bulk of tariffs have so far been passed to US buyers. With the next round of hikes inevitably more focused on the consumer, this will raise the CPI. Suttle says the end result is lower growth, and higher inflation, which is equal to a classic supply shock. .

The new cold war, inflation and financial repression

Russell Napier, author of  The Solid Ground newsletter, is a renowned global strategist and financial markets historian, who has in recent years written extensively on what he sees as a gradual shift in the existing global monetary order. He’s also written a lot about the requirement for financial repression to quell the ever expanding debt/GDP ratios in the world’s developed economies. In his most recent edition of The Solid Ground, Napier turns his attention to the latest developments on the US-China trade war, in what is increasingly beginning to resemble a cold war. This presents some existential problems for China’s policy makers, he says, and will likely result in the end of its existing monetary policy framework, which will become unsustainable, and result in a shift to an independent monetary policy. This scenario would mark the most significant event since the fall of the Berlin Wall, says Napier. It is important for investors to understand what would happen next. Napier thinks that it will mark the end of the deflationary era, and a new period of inflation, and with it, financial repression will be employed to inflate away the debt. Back in late 2016 Napier published his thesis on the implications of what financial repression would mean for global markets in this current era. He will be holding a seminar on his latest thoughts on financial repression in London later this month. To read Napier’s latest edition of the Solid Ground, click below to register on the ERI-C research platform, where you can also access all of his recent issues.

Corporate debt is not too high

Goldman is unfazed by US debt reaching all-time high as a share of GDP. The firm argues on May 4 that corporate debt remains below the 2001 peak as a share of corporate cash flows and has declined since the mid-90s as a share of corporate assets. These measures are seen as more meaningful as they better capture the risks of illiquidity and insolvency. Further, the structure of corporate debt has shifted toward longer maturities and refinancing risk has declined as corporate bond yields have become less volatile Default and spread widening risks are acknowledged, but are seen as no larger than in previous cycles. Goldman doesn’t expect high corporate debt to trigger a recession.

Shipping index contraction points to German recession in second half

Latest trade data points to strong likelihood of a German recession in the second half, Southbay says, pointing to a 6% contraction in the Southbay EU Shipping Index. For the EU as a whole, contraction in trade is strongly correlated with economic weakness. But it’s worse for Germany, Southbay says, where trade is a proxy for manufacturing. Germany also faces long­er term problems as an exporting economy which faces increased competition from China as well as slowing auto demand. Southbay’s indicators have worked very well in the past 12 months on Europe.

Europe’s Machiavellian moment

Inferential Focus bring a unique approach to investment research. They utilise the technique of inference reading (from hundreds of different reports and articles), which overcomes bias and goes beyond the wisdom of the herd. Their breadth enables them to locate change prior to identification or impact in specific industries or locations. In a recent report they analyse their findings on the upcoming European elections, which reveals something of a double edged sword amid the rise of populism on the continent. If the populists are defeated in European elections, their reactions this time could be politically problematic and even violent, their work concludes. If populists win, the resulting disunity could also lead to an upsurge in violent conflict. Pushback against the more negative policies of the populists has started to gain ground in some countries, and voter turnout is seen as the likely key to the result. The spectre of Russia’s influence is never far away too. Inferential argue that Russia will seek to disrupt the elections and push voters to support populists, which will test the ability of democracies to limit the influence of cyber-hacking.

What the PMIs told us last week, and other indicators

The bad news is that the global economy is still slowing. The good news is that similar soft patches in the past were followed by faster growth, writes Yardeni Research. The firm provides a thorough breakdown of the recent global PMIs, which they say indicates neither boom, nor bust. In terms of other indicators, their favourite indicator of global economic activity is the CRB raw industrials spot price index, which after rebounding earlier this year, has begun to meander again in recent weeks, which seems to confirm the slow-go mode of global PMIs. To track global growth, Yardeni monitors weekly forward revenues of the US, Developed World ex-US, and Emerging Markets MSCI stock composites. Here, they see no sign of recession in these composites. Finally, to track domestic economic activity, Yardeni tracks a whole host of US transportation indicators. These seem to be slowing, or stalling at record highs. Something to watch.

Investors pivoting to safer credit; high-yield sees outflows

Central banks’ dovishness and low inflation have been a tailwind for fixed income securities, and credit in particular, BofAML argues on May 10. Investors remain willing buyers of ”quality yield” but risk sentiment is driving investors away from high yield funds. If US-China trade wars fail to de-escalate soon, the global “desynchronised growth” narrative will be threatened, BofAML says. This could kill the ”green shoots” emerging at present in the German and euro zone economies.

Auto tariffs: Friday’s ”Section 232” deadline set to up the ante on European autos

Friday is the deadline for Trump to act on Section 232 auto/auto parts report, which then brings Europe into the trade war fray. However, Cowen & Co’s Washington Research Group think that if Trump chooses to enter into negotiations to limit or restrict the articles found to impair U.S. national security, he has an additional 180 days beyond May 17 to conclude such an agreement. This is their base case. They believe the report will be used to justify a 25% tariff (quotas for Canada and Mexico per the detailed USMCA side letter – and likely South Korea, though that is less certain). The possibility of an extension is largely due to a lack of trade wins in Q1 as neither USMCA or China have been concluded, i.e. don’t start new trade wars with Europe and Japan before the current ones are resolved, the Cowen report says. but tariffs aren’t the only option, and the report sets out various scenarios that combine tariffs and quotas.