All posts by Daniel Lacalle

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

Eurozone Growth Seems To Have Peaked

Global Economy, On the cover, Sin categoría
Old Europe continues to reveal its old problems: Overcapacity, companies in difficulties and an aging population that has more conservative consumption patterns

European PMIs for July in the eurozone have shown how difficult it is to continue to believe in the mirage of growth that has been sold to us by Old Wall Street after Macron’s victory in France.

It is important to highlight the difference between a modest recovery and excess optimism, and in the euro area markets have gone from the first to the second without calibrating real hard data.

Both manufacturing and service PMIs continue in expansion mode, but France shows the weakness to which we are accustomed in an economy that promises reforms and has delivered stagnation for two decades, similar to what happens with Italy. More importantly, data from Germany also indicates a slowdown in this expansion.

This graphic courtesy of Morgan Stanley is very revealing. It shows the relationship between PMI indicators and GDP growth, and how data peaked in the past months.

 

 

There are other interesting variables that confirm the modestly positive but not euphoric tone of the European economy. Gross capital formation growth of 6% is positive, but the level of overcapacity in the European Union continues above 20%, therefore investment is still well below 2009 levels.

The investment expectations of the non-financial sectors point to an almost imperceptible capital expenditure (capex) increase in 2017, and certainly not above the average depreciation rate, which indicates that companies do not see an attractive environment for investment despite ultra-low rates, and too much of capital goes to real estate, construction and capital recycling (mergers and acquisitions).

The euro zone increase in consumption and credit growth are decent but modest, yet well below the growth of the money supply, at least a third less. Not surprisingly, with 1.2 trillion euros of excess liquidity in the eurozone, markets have opted for aggressive multiple expansion of stocks, well above the growth of adjusted real profits. That is why we must pay attention to the macroeconomic reality, to avoid falling into the trap of euphoria.

The latest Bank of America data reminds us that in Eurostoxx 600 almost 9% of companies can be considered “zombies”, ie their generation of operating profits does not cover the cost of interest payments, despite historically low-interest rates and huge liquidity. With a banking system that continues to accumulate almost 900 billion euros of non-performing loans, this is a combination that investors should not ignore.

Old Europe, therefore, continues to reveal its old problems: Overcapacity, companies with difficulties and an aging population that has more conservative consumption patterns. That is why we maintain our expectations for Eurozone growth unchanged for 2017 and 2018, and we expect confirmation in corporate earnings of a guidance for moderate improvement in margins and balance sheets.

Economies that are betting on structural reforms are leading growth, but we cannot ignore the fact that two of the largest economies in the eurozone, France and Italy, face enormous challenges that are unlikely to be solved betting that monetary policy will solve everything.

Daniel Lacalle is Chief Economist at Tressis SV, has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

Images courtesy Google

The Rise of Zombie Companies, And Why It Matters To You

Global Economy, On the cover, Sin categoría

The Bank of International Settlements (BIS) has warned again of the collateral damages of extremely loose monetary policy. One of the biggest threats is the rise of “zombie companies”. Since the “recovery” started, zombie firms have increased from 7.5% to 10.5%. In Europe, Bof A estimates that about 9% of the largest companies could be categorized as “walking dead”.

What is a zombie company? It is -in the BIS definition- a listed firm, with ten years or more of existence, where the ratio of EBIT (earnings before interest and taxes) relative to interest expense is lower than one. In essence, a company that merely survives due to the constant refinancing of its debt and, despite re-structuring and low rates, is still unable to cover its interest expense with operating profits, let alone repay the principal.

This share of zombie firms can be perceived by some as “small”. At the end of the day, 10.5% means that 89.5% are not zombies. But that analysis would be too complacent. According to Moody´s and Standard and Poor’s, debt repayment capacity has broadly weakened globally despite ultra-low rates and ample liquidity. Furthermore, the BIS only analyses listed zombie companies, but in the OECD 90% of the companies are SMEs (Small and Medium Enterprises), and a large proportion of these smaller non-listed companies, are still loss-making. In the Eurozone, the ECB estimates that around 30% of SMEs re still in the red and the figures are smaller, but not massively dissimilar in the USD, estimated at 20%, and the UK, close to 25%.

The rise of zombie companies is not a good thing. Some might say that at least these companies are still functioning, and jobs are kept alive, but the reality is that a growingly “zombified” economy is showing to reward the unproductive and tax the productive, creating a perverse incentive and protecting nothing in the long run. Companies that underperform get their debt refinanced over and over again, while growing and high productivity firms struggle to get access to credit. When cheap money ends, the first ones collapse and the second ones have not been allowed to thrive to offset the impact.

Low interest rates and high liquidity have not helped deleverage. Global debt has soared to 325% of GDP. Loose monetary policies have not helped clean overcapacity, and as such zombie companies perpetuate the glut in many sectors, driving down the growth in productivity and, despite historic low unemployment rates, we continue to see real wages stagnate.

The citizen does not benefit from the zombification of the economy. The citizen pays for it. How? With the destruction of savings through financial repression and the collapse of real wage growth. Savers pay for zombification, under the mirage that it “keeps” jobs.

Zombification does not boost job creation or buy time, it is a perverse incentive that delays the recovery. It is a transfer of wealth from savers and healthy companies to inefficient and obsolete businesses.

The longer it takes to clean the overcapacity -whcih stands above 20% in the OECD- and zombification of the economy, the worse the outcome will be. Because, when the placebo effect of monetary policy disappears, the domino of bankruptcies in companies that have been artificially kept alive will not be offset by the improvement in high added-value sectors. Policy makers have decided to penalize the high productivity sectors through taxation and subsidize the low productivity ones through monetary and fiscal policies. This is likely to create a vacuum effect when the bubble bursts.

The jobs and companies that they try to protect will disappear, and the impact on banks’ solvency and the real economy will be much worse.

Avoiding making hard decisions from a crisis created by excess and overcapacity ends up generating a much more negative effect afterwards.

Daniel Lacalle is Chief Economist at Tressis SV, has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

Images courtesy Google

(Data BIS, Moody’s, S&P)