A further election in Greece likely

Australia’s trade deficit increased to A$1.587bn in March, the 3rd consecutive decline and higher than the revised deficit of A$754bn in February. The deficit was the largest since October 2009 and higher than the A$1.3bn forecast. With weakening demand for commodities from a slowing China, Australia is likely to face continued deficits, weakening the A$ further. In addition, a slowing global economy and likely lower inflation should enable the RBA to cut rates further, once again putting pressure on the A$. The PM, Ms Gillard, remains beleaguered and personally, I cant see her surviving for very much longer, though her exit should provide some respite, indeed a rebound in markets, the A$ and sentiment generally;

Australia released details of its budget today. The Government will cut spending (the 1st time in 42 years) to return to a budget surplus, forecast at A$1.54bn for the year ending 30th June 2013. The move by the Government is an attempt to get the RBA to reduce interest rates (which it will) and so ease pressure on home owners in respect of their mortgages. Cant see this move helping the beleaguered Ms Gillard;

India has retreated on tax proposals which would have impacted foreign investors. The authorities have delayed the new rules until the next fiscal year commencing on 1st April 2013. However, a delay will not prove enough to turn around flagging sentiment in my humble view and with large trade, budget and current account deficits, I continue to believe that India is likely (indeed, probably will) face some kind of funding crisis in due course. The recent decline in oil will help ease inflationary pressures. I remain particularly bearish on India – the market closed -2.5% lower today;

Mr Putin’s return to power as President was greeted by violent protests in Moscow. It looks likely that protests will continue, as Russia fails to introduce much needed reforms – the current political structure and the power of vested interests will limit progress. Putin is pressing ahead with privatisation – he needs to, as he has to fund the governments spending programme. It is estimated that Russia needs a US$1117 Brent oil to balance its budget – roughly 50% of Russia’s tax revenues is derived from energy. The Rouble should weaken further and capital flight will continue. Cant see the Russian markets improving either, even though they are very cheap. However, Russia will become more amenable to joint ventures with foreign companies – expect a number of deals in the energy sector;

The Spanish authorities seem intent to recapitalise its 3rd largest bank, Bankia. An injection of some E7bn – E10bn of Coco’s (contingent convertible bonds) bonds is proposed. Well great, but Bankia will require far far more capital, as will the Spanish banking sector. However, Spain does not have the money necessary. It is only a matter of time before Spain requires some form of bail out, though the EZ/IMF bail out funds available are just not sufficient. Once again, a complete mess in the EZ;

Mr Samaras, the head of the Greek political party (New Democracy) which won the most votes gave up trying to form a coalition in just 6 hours. The anti bail out party (Syriza), headed by Mr Tsipras, has now been given the opportunity, which looks set to fail. New elections in June are the most likely outcome, as a stable coalition proves elusive for any of the parties. However, another election is unlikely to resolve Greece’s problems. The Greek government has to approve further austerity measures, amounting to E11.5bn, to obtain further tranches from the EU/IMF bail out funds. It is clear to me that a political solution in Greece will prove illusive and its time for Greece to exit the Euro. Personally, I believe that a Greek exit from the EZ within 1 year is a near 75%+ certainty. Contagion in the EZ will be the issue, but both Portugal and Ireland can and indeed, will, be saved. The next critical country remains Spain which however is a very different ball game;

France will have a new President. Mr Hollande was elected, as expected, though the margin of his victory was less than expected. Elections for seats in the lower house (the National Assembly) are scheduled for June. A left leaning coalition won the majority of seats in the upper house late last year. If Mr Hollande fails to win a majority in the National Assembly, he will have to pick a PM from conservative ranks. It is unlikely that there will be many policy issues announced ahead of these elections. The outcome of the impending elections will determine whether France proceeds with a much lefter leaning policy or not. It is also going to be interesting to see how Mr Hollande’s calls for growth will be viewed in Berlin. The EU is also calling for much more growth measures – what these are are not defined, though very likely to involved capex projects funded by the European Investment Bank. Sounds good, but will not resolve the problems in the EZ;

German March industrial output rose by +2.8% MoM (-0.3% in February), much higher than the +0.8% forecast. German economic data has picked up recently. However, I for one, do not believe this will continue in the 2nd half of the year. Recently, the country’s economy has picked up following an increase in domestic consumption and construction, in particular. Exports to EM’s have also increased;

One bit of good news from the EZ – Irish consumer sentiment rose to 62.5, in April, from 60.6 in March – consumption of the black stuff must be increasing;

Outlook

The Euro, in spite of all the obvious problems in the EZ, has been remarkably resilient. It is thought that EZ banks are repatriating funds derived from asset sales, mainly in Asia, combined with buying by China (to protect their exporters, as Europe remains China’s largest trading partner) are the main reasons for the Euro’s resilience to date. However, the recent outcome of elections in Greece and France has negatively impacted the Euro, which is now trading at the low point of its recent range. I remain short and, in addition, expect the Euro to decline well below US$1.30 (currently US$1.3005) in coming months and towards US$1.20, as political tensions increase in Euro land. Also short the A$, against the US$ for full disclosure purposes.

I remain bearish and believe there is far more downside risk out there. I will continue with my shorts on Spain, India, EZ (French and Spanish banks) and the miners and have added a short on France, with some large cap, div paying consumer staples and tech stocks as longs.

Oil is trading slightly lower today – currently Brent is around US$112.

EZ markets recovered from an initial sell off yesterday – cannot understand why. They are lower today – France nearly 1.5% lower.

Kiron Sarkar

8th May 2012