Heading To The Exits

by: Mark J. Grant

Europe has tried a grand experiment for a number of years now. It has worked out well for Germany, who initiated the European Union and prodded it along, and not so well for a number of other countries. In my opinion, the issue is not really Populism but Tribalism. Each European nation is a tribe unto itself. Many European countries, I believe, are just plain tired of having the bureaucrats in Brussels, orchestrated by the bureaucrats in Berlin, telling them how to run their own countries. I think the EU has just about run its course and, as many lead banks suggest investing in Europe now, I am of the opposite opinion.

I think investments in Europe are quite frightening and inadvisable at this point in time and so I take my stand on the other side of this fence.

In my view, I believe the problems in Europe are both political and economic. I point first towards Italy where the deficit, if believed, is running at an admitted 133%. However, that is not all of the story.

The ECB states that the EU has $1.05 trillion in nonperforming loans with $420 billion being resident in Italy which is 40% of the total, according to the New York Times. Italy's unemployment rate has grown from 4.95% to 12.5% in the last year. According to 2017 data from the Heritage Foundation, Italian government spending has amounted to 50.9% of total output (GDP) over the past three years, which is an increase of 22.3%.

If you just took Italy's debt, $2.852 trillion, according to Bloomberg data, and added in the Italian banks' non-performing loans, the debt to GDP ratio would be 157%. This, in my view, is a disaster in process and while the EU's rules mandate that subordinated bondholders and equity holders must take the first losses, this is not simply an economic issue. The vast bulk of these holders are Italian citizens who may get driven into, and already leading in the polls, the Five Star Movement, which wants to exit the European Union and the euro.

I think this is a time bomb ticking, as Italy will head to elections at some point soon.

Grexit is at the door, once again, as the IMF, to date, has refused to participate in any new bail-out schemes. I do not believe they will participate, with the Trump administration now in charge of the IMF's U.S. contingency, and I find all of the positive comments by the EU politicians, that we are moments away from the next bail-out, to be little more than a children's fairy tale. I am watching these people's noses grow longer and longer and longer.

A lie keeps growing and growing until it's as plain as the nose on your face.

- Pinocchio

In my opinion, Greece is going to finally exit from the EU, as their July debt payment comes into focus. They may leave, or they may be forced out, as both the EU and the ECB are right up against their spending limits for both the country and the Greek banks. Push is about to come to shove, in my view.

And now, gentlemen, like your manners, I must leave you.

- Dylan Thomas

Then we have Frexit, and Ms. Le Pen, and while the odds currently favor Mr. Macron, in the final round of voting, this may not be the case as we near the final election. Ms. Le Pen also wants to exit from the EU and return to the franc and the odds are not so long that they cannot be overcome. This is a work in progress. I would not be so arrogant as to count Frexit out. The balance may yet swing if more terrorist acts are forthcoming or more political surprises, such as what happened to yesterday's favorite, Mr. Fillon.

Then there is a new concern. It has barely been spoken of in the Press and yet the Swedish Democrats may now be the largest political party in Sweden. They too, want out, as Fox news reports that a new YouGov poll shows that 39% of Swedes want to leave the EU and their election is in September. Swexit may arrive this year.

All the world's a stage, and all the men and women merely players: they have their exits and their entrances.

- William Shakespeare

So, Brexit is underway and Grexit, Frexit, Italgo and Swexit are possible and that all adds up to a considerable amount of risk, in my estimation. This would be Risk with a capital "R." The point here is that there is not enough reward for investing in Europe to off-set the considerable Risk that is present. I submit, when the balance hangs in the favor of Risk, and the balance for Reward is minimized by it, then the Risk/Reward equation is not in your favor.

I would also state that fundamental economic analysis can get tossed on its backside by "events" and that there is not one, but a multitude of "events," that could flop the European Union on its backside and flay Brussels to the bone, as it runs the "Exit Gauntlet."

"Take heed," I say. The European construct is at a major tipping point and the flashing lights are blinking red. There are plenty of places to invest money and I just do not see Europe as a stable environment now. If there was enough reward to justify the risk I would have a different opinion but there is not.

Caveat Emptor (Buyer Beware).