Germany and the coming Greek default

|By Matein Khalid| In retrospect, 2016 will go down in German political and economic history as a significant game changer, on the scale of 1989 (fall of the Berlin Wall), 1990 (reunification) and 1999 (the Euro), even 1945 (launch of Deutschemark), 1945 (Third Reich surrenders), 1943 (Stalingrad) and 1933 (Hitler elected). Chancellor Merkel, renamed Mutti Multi kulti, allowed a million migrants to settle in Germany. The far right AFD party’s support base has tripled in only one year from 5 to 15%. For now, there is no prospect of an Austrian style far right takeover. (Edelweiss, edelweiss, bless my homeland forever!).

The Christian Democrats still command one third of the voters and have coalition allies in the Bundestag. The German economy is not in deep depression. The sixteen Lander (states) and civil society have embedded democratic political cultures. The “social market economy” of West Germany’s Wirtschaftswunder (economic miracle) decades promotes consensus in policy making, even though Finance Minister Wolfgang Schaeuble is a hard money nationalist. The Euro has been a trillion dollar export windfall for Deutschland AG. The center right will continue to dominate German politics, even if Frau Merkel is no longer Chancellor.

2016 is not 1933. However, as I watch the woes of German banks, I cannot help thinking about the banking dominoes of the early 1930’s. The run on the Creditanstalt in Vienna. The fall of Darmstädter Bank. The Nazi takeover that followed the 1932 banking crisis, not the 1922 Weimar Republic hyperinflation. Thankfully, the German elite embraced the single currency project, despite the fiscal and constitutional compromises of Maastricht and Lisbon. Thankfully, the Bundesbank and the CDU allowed the ECB to depreciate the Euro in 2014-15. If Germany had still retained the old Deutschework, it would have surged to epic highs after the twin shocks of Lehman and Cyprus/Greece, akin to the Swiss franc. The German economy, one third of the Eurozone, would have gone into recession and the Elysee Palace would have been haunted by the ghosts of “franc-fort!”. Yet despite the Euro at 1.12, the migrant crisis has led to the meteoric rise of a xenophobic, anti-EU far right political party. This is bad news.

The ECB’s money printing is anathema to a German elite still traumatized by the horrors of the Weimar Republic hyperinflation and the loss of its beloved Deutschemark, the monetary anchor of the Bundesrepublik Deutschland. German Finance Minister Wolfgang Schäuble is intransigent about debt relief for Greece or a fiscal stimulate to revive EU growth. Germany’s policies threaten to plunge Europe into another deflation quagmire, even though first quarter GDP growth was 0.5%, thanks to the sharp falls in oil and the Euro in 2015. German spending on migrants and leniency shown by the Eurocrats in Brussels for President Hollande’s labour reforms has also boosted the path of Eurozone growth rates. Yet German politics, not just the cold hard money DNA of the Bundesbank, will determine Berlin’s response to the latest IMF package for Greece, the Brexit vote, French labour reforms, G-7 currency politics or potential fiscal stimulus to boost peripheral economic growth.

While the German DAX index has had a dismal 2016, thanks to the big chill from China on Frankfurt’s global exporters, I believe investors should focus on German stocks that benefit from domestic consumption, higher wages and the lowest borrowing rates since the Treaty of Westphalia. IG Metall and the chemical unions have agreed to 5% pay rises for more than 1.2 million German workers. Berlin has also raised pension payments to their highest levels since the Helmut Kohl era.

I believe the financial markets have not priced in the risk of a sovereign Greek default in July, without an IMF bailout deal. It does not help that the Greek government resists pension overhauls and Berlin (Bruder Wolfgang bitte!) rejects even an iota of debt restructuring. Without German approval, no Troika bailout is possible, let alone credible. As populist parties, an anti EU backlash and the migrant crisis reshapes Europe, I doubt if Chancellor Merkel can win a voter “jawohl” for an IMF Greek deal. The IMF must now battles Berlin over a debt relief deal for Greece that is political suicide for Frau Merkel if rejected by the electorate. The IMF proposal to delay Greek debt repayment to 2080 (no typo. 2080 Anno Domini) is nuts. The Bundestag will not vote for Greek debt relief if the IMF does not lead a bailout plan. This is 2008 all over again, only worse. So Achtung baby, Grexit and stay short Deutsche Bank (down 48%)!

Macro Ideas – What next for Indian and Hong Kong shares?

My strategy idea to buy Indian bank shares ahead of the Union Budget and the RBI rate cut made serious money, with a 15% surge in ICICI Bank. Yet Indian equities are not immune to global risk aversion and King Dollar, as the rupee’s fall to 67.40 attests. Despite the BJP win in Assam, passing of the bankruptcy code and a “good” monsoon, India is expensive at 17.8 times earnings, a valuation that does not permit any new earnings disappointments, macro shocks or Wall Street black swans. So I can easily envisage the rupee at 68 on the eve of the June FOMC and the Nifty can fall again to 7600, another ideal short term entry point. Positioning is ideal in Indian equities, as even NRI friends are skeptical about the prospects of Dalal Street. Sadly, too many of my NRI friends in Dubai dissed my pleas to short the Indian rupee at 45 in July 2011, since the money supply surged 20% due to then Finance Minister Mukerjee and RBI Governor Subbarao’s ignorance of monetary economics and credible central bank policies. They were devastated in India when the rupee lost 45% of its value in 2011-13 and thus unwilling to believe me when I went gaga on the Modi bandwagon in late summer 2013. I attended an Emirates Hills party where our Sindhi host gave us a “tip” that India’s sovereign credit downgrade was imminent. The next evening, I immediately went long Indian ADR’s in New York since nothing is so contrarian and persuasive as Emirates Hills “crowd consensus”, both Amil and Bhaiban! Psss, wanna buy tip top K12 British curriculum school baa?

India is a de facto growth stock, a money spinner but only at the right price. Volatility shocks is to Dalal Street what a cross of gold is to Count Dracula – and the vol index has risen to 17. Yet the macro data tracked by my Indian equities guru Himanshu Khandelwal at Asas Capital points to a cyclical growth uptick. Cement, power consumption, freight rates, steel usage, construction equipment and commercial vehicles sales all confirm Himanshu’s sector call. The RBI’s decision to lower cash maintenance limits on bank reserves have eased stresses on the interbank market and, with the repo rate at 6.5%, the yield on the ten year Indian G-sec is 7.5%. Consensus earnings (as usual) is iffy at 17% but Himanshu’s proprietary models find us at least a dozen potential three baggers in the netherworld of the Nifty cosmos. I hear the monsoon came a week early in Kerala. I find it significant that Sensex volatility metrics are now lower than those in China, South Korea, Thailand and Malaysia. The cognoscenti whisper that Arun Jaitley will soon stun the world with a an Indian sovereign credit rate cut upgrade. Stay tuned!

Hong Kong’s Hang Seng index has fallen 32% since last summer in one of Asia’s most brutal bear markets. The reasons? Beijing’s crackdown on occupy Hong Kong and the media, the Macau anti-corruption crackdown, the ghastly derating of Stan Chart and HSBC, the 25% King Dollar rally, a property crash in the Crown Colony turned SAR and successive meltdown in Mainland H shares due to regulatory/policy mismanagement. Of course, tourism arrivals from China have plunged, the reason for a 30% fall in retail sales despite capital flight from the Middle Kingdom.

Even though Hong Kong is 1000 Hang Seng points above its February 2016 lows, I would stay short its index fund, symbol EWH. A Fed rate hike will lead to a capital exodus from Hong Kong, thanks to the dollar peg. I also cannot accept street consensus for 7% profit growth in Honkers large caps in the Hang Seng index. In fact, I believe earnings growth will be negative as the debt chickens from China’s trillion dollar Ponzi scheme (shadow banking system) come home to roost. If the biggest credit Frankenstein in history awakens, the South China Sea is ground zero. Hong Kong’s equities and property market bubbles unravel whenever the US dollar surges, exactly as happened in the GCC since 2014. The currency peg hits retail, tourism, loan growth, the cost of bank risk, collateral values, funding costs and asset prices at the same time. Dozens of smaller Chinese banks and developers will not survive the property crash. I expect the Hang Seng index can fall to 17000 by end of 2016.

Currencies – The short Singapore dollar trade idea was a winner!

My tactical idea to short the Singapore dollar at 1.35 for a 1.40 target is now in the money as Southeast Asia’s ex hard money Swissie, current sad sack China trade proxy has depreciated to 1.38. This has also vindicated the Bharat Mata (Mother India) carry strategy (long INR/short SGD) even though the rupee has sunk to 67.40 as I write. My opinions mean squat when the hoofbeats of the herds are on the move and the herds of Planet Forex scramble to buy King Dollar now that the Federal Reserve has begun to play mind games with the world ahead of its June monetary conclave.

Aunty Janet’s Politburo (also known as the FOMC) has begun to huff and puff about a June rate hike, as the April minutes showed. The Fed claims to be “data dependent” but it is really market and chairman ego (at least under Helicopter Ben and humbled Maestro Alan) dependent. There is an open revolt against Dr. Yellen’s dovishness among the inflation hawks of the FOMC – Dudley, Lacker, Fischer, Williams and Lockhart. The 2.5% rise in wage growth gave the FOMC hawks the intellectual ammunition they needed to sqwak about a June rate hike.

The entirely predictable result? A global scramble to accumulate King Dollar. Hence the logic of my short Sing dollar at 1.35 trade idea. The Buckeroo, after all, is the planet’s currency safe haven of the last resort and in times of (geopolitical binary event risk) stress, the financial markets go ballistic and go home to Mommy and global Mommy Central is the United States. Hence the seven week low in global equities, the rise in the Volatility Index to 17 and the money making macro trades shorting high beta emerging market currencies, from the Turkish Lira and the South African Rand to the Russian Rouble and Brazil Real.

Southeast Asia’s high beta, politically toxic, off balance sheet debt crippled currency is the Malaysian ringgit. After all, 50% of ringgit debt is held by foreigners and $6 billion of Malaysian sovereign wealth fund’s assets have ended up acquiring a suntan in the Swiss Alps, even though billions flowed right back in the personal accounts of bumiputra political luminaries. Boys will, of course, be boys in the Third World, when the cookie jar is full of hard currency!

The binary macro risk in June are crystal clear. The Brexit vote. The Republican convention circus. Khalid Al Fahih’ first OPEC meeting as the new Saudi oil minister. A tragic Egypt Air plane crash in the Greek isles.

The irony about the current scramble into embrace King dollar is that April payrolls were soft while global financial conditions had begun to ease with gold at $1300, Brent at $48, the Uncle Sam ten year note at 1.70%, credit spreads narrower and the Chinese yuan stable. The market was positioned dangerously short dollars, hence the FOMC chicken hawk inspired squeeze.

Ironically, the dramatic bull markets in the risk assets since mid February, from oil to Brazil, West Texan high yield debt to the price of copper and gold, were also triggered by shifts in Fed rhetoric, as Dr. Yellen did her best in successive meetings to talk the US dollar down after the Shanghai G-20, a de facto Plaza Accord echoed by subsequent ECB and Bank of Japan rate meetings since March. The December FOMC rate hike and FOMC dotplot projections of four 2016 rate hikes triggered a 300 point meltdown in the S&P 500 index and financial carnage in China/emerging markets. So Janet Yellen panicked in February and sang dovish sweet nothings to the bond market. So the Euro surged to 1.15, the Japanese yen to 106, money center bank shares sank and oil was up 72% from its lows. Now the risk rally has unraveled again as the Federal Reserve debates QE exit.

Two dark macro (ichimoku?) clouds scare me. One, both Hilary Clinton and Donald will ratchet up protectionist rhetoric against China and Japan in the endgame to the US election. This means Taro Aso will be unable to intervene (politics, my dear Watson!) as the Japanese yen surges above the BOJ samurai’s “line of death” at 105. The prospect of dollar yen at 96 will trigger a global financial crash. Two, the US Treasury yield curve has begun to flatten, exactly as it did in the countdown to the great crash of 2008. The current two/ten Uncle Sam debt yield curve is the flattest since November 2007, the month the stock market peaked and global crisis began. Cicero said that not to know history was to forever remain a child. Only a fool bets against history and I hope I am no fool.