Depth report

　　

The 2016 Brexit referendum and the aftermath of the U.S. presidential election were unsettled, and the 2017 European Super Election year kicked off. We believe that while you are reading this article, you are also waiting for the results of the Dutch parliamentary elections. As the theme of the election revolves around expelling refugees and exiting the European Union, the results and subsequent developments will set the tone and have a ripple effect on the general elections in France in April-May, Germany in October, and Italy, which may be held in advance in June. Our experience in Hong Kong is particularly subtle. The fifth Chief Executive election on March 26 is not far away. The difficulties faced by the Hong Kong government in the past two or three years include not only the rise of Hong Kong independence, but also what domestic residents have rarely heard of. Fake refugees flocked to Hong Kong. People often worry about the international black swan incident, but they may not realize that the Hong Kong election may also reveal unexpected results.

    Let's not talk about Hong Kong today, but mainly from the perspective of investors, talk about the possible outcome of the European general election within half a year and the economy and future of the European Union (or the Eurozone, if it is not necessary to distinguish it below).

    In the past two months, the EU’s basic economic data, especially corporate earnings data, have continued our judgment in the article "Europe: Dilemma or Turnaround" and continued to improve. In addition to the depreciation of the euro and the pound, the stocks and debts of core countries have both risen. But from another angle, we can still see the cautious attitude of investors before the European election. As one of the typical safe-haven assets in Europe, the yield of German government bonds has always been a weather vane for European market risks. In the past half month, the yield of German government bonds has begun to fall all the way, and the spread of French government bonds relative to Germany has also continued to rise.

    The game between the various forces before the election in the Netherlands is not the focus of investors’ most attention. Not to mention that the Liberal Party, which insists on the right-wing claims, has lost its lead in recent polls. Even if it wins, it will face resistance from other parties to the joint cabinet and a referendum on Brexit. support. Ten thousand steps back, even if the Netherlands holds a referendum and decides to leave the European Union, the impact will be limited. The Netherlands is a special country in the Eurozone. She is one of the few countries with low debt ratios, similar to Germany, and has not owed large amounts to the European Central Bank. Economically relatively healthy. Even with Brexit, the Netherlands, as a small country, is very dependent on international trade. Withdrawing from the euro zone does not mean that it will not trade with European countries. Therefore, the economic impact of the Dutch Brexit on the euro zone may not be so great. However, the Netherlands is one of the founding countries of European integration, so the psychological and political impact of her Brexit on European people cannot be underestimated.

    A realistic view of the short-term impact of the Dutch election should be reflected in the fate of the Liberal Party and how the public opinion supporting it will be transmitted to the French presidential election, because the leading position of the National Front, which has similar political views with the Liberal Party, in the poll support may remain until The first round of general elections in April. The three key words surrounding the leader of the National Front, Le Pen (extreme right) are France first, trade protectionism, and withdrawal from the euro zone. It is no wonder that she is called the "female version of Trump." In the second round of the general election in May, she will encounter resistance from Macron (center-left) or Fillon (center-right). Although current polls show that she lags behind the first two with 40% and 45% support respectively, Don’t forget that last year’s Brexit support was only around 40% in the two months before the referendum. Of course, even if Le Pen wins consecutively to become the president, it is still extremely difficult for her to obtain parliamentary support to hold a referendum on Brexit.

    It is particularly worth mentioning that Macron, the "dark horse" who seems most likely to become the French president, was only 39 years old, and he was once the Minister of Economy in Hollande's cabinet. His campaign platform includes reducing corporate tax from 33.3% to 25%, changing wealth tax to real estate wealth tax, and no longer paying capital tax. These are conducive to entrepreneurs and the rich; on the other hand, he wants to treat 80% of the Families are exempt from housing tax; through reform of the unemployment insurance system and strengthening of continuing education, the unemployment rate will be reduced to 7% by 900,000 unemployed people within five years. These are leftist measures and will win the support of ordinary voters. In addition, his 50 billion euro public investment plan is also generally welcomed, no wonder the market positions him as a middleman. Macron also said that after his election, he will legislate to govern politicians' moral issues. In the country's management of public affairs, ministers and parliamentarians are prohibited from hiring family members, and parliamentarians are prohibited from engaging in (private enterprise) consulting activities. In my opinion, these claims of Macron are far closer to Trump's shrewd and pragmatic campaign platform than Le Pen. Unlike Trump’s American priorityism, Macron said that after being elected, France is willing to assume more responsibilities and burdens in the EU to help marginal countries with relatively backward economies, and is willing to give the latter more time to carry out a structured economy. reform. There is no doubt that the capital market is looking forward to the final victory of Micronaire.

    Compared to the Netherlands, France, the German elections in October in the second half of the year, and the Italian elections that may be held in June may bring greater damage to the market. After all, the current polls show that the joint support of the major parties that advocate Brexit has exceeded. 45%. We mentioned in the article "Europe: Dilemma or Turnaround" that the crisis in the Italian banking industry will also become extremely complicated as the general election progresses.

    We have repeatedly emphasized in a series of previous articles that the impact of political events on the capital market is far less serious than everyone imagined, and the duration is much shorter than the endogenous crisis in the capital market. In addition, Microsoft founder Gates said that "people tend to overestimate the changes in the next two years and underestimate the changes in the next ten years." Gates emphasized technology, and we want to remind everyone that this sentence is equally valid when used in economics and politics. Although the performance of European economic data in the past six months has been gratifying due to market expectations, the three economic imbalances faced by the EU will exist for a long time. First, the trade imbalances of member states. For example, Germany continues to accumulate trade surpluses, while Italy’s trade deficit cannot be made up. Second, the debt imbalances of marginal countries. Except for the familiar debt crisis of Greece, other southern European countries such as Italy, Spain, and Portugal are also heavily in debt. Third, the bank funds of member countries are imbalanced. Once there are signs of a crisis, safe-haven funds will leave countries with weaker economies and flock to countries with stronger economies.

    Since 2008, bank funds have continued to flow from the aforementioned southern European countries, France, and Austria to Germany, the Netherlands, and Finland in the north. Countries facing capital outflows can only continue to raise funds from the European Central Bank. At the same time, the non-performing loan rates of these countries are too high, which also brings great risks to the collection of the entire banking system. Therefore, once the European Central Bank no longer provides financial assistance to these banks, they can only request assistance from their own countries. , Or sell a lot of bank assets, and may even go bankrupt in the end.

    Brexit has produced a domino effect, and the Brexit proposal has become a good card for politicians to attract popular support. But can Brexit solve the problems caused by the Eurozone?

    In terms of debt issues, if the Eurozone disintegrates, then the borrowing costs of countries must be redefined and readjusted according to their respective countries’ productivity, economic status, debt levels, and so on. There is no doubt that the national debt yields of Italy, Spain, Greece and other countries will rise sharply, and the country may not be able to bear the consequences at that time. From the perspective of the banking system, according to the European Central Bank's regulations, if a country wants to leave the European Union, it must first pay off the European Central Bank's arrears. According to current data, Italy and Spain owe the most. If they leave the European Union, Italy and Spain's banking industry may not be able to withstand bankruptcy without the aid of the European Central Bank. On the other hand, if the European Union disintegrates, and large and small arrears countries collectively default on their accounts, Germany will have to bear almost all the risks.

    Therefore, Brexit is not so easy, and the consequences of the disintegration of the EU are even more unbearable for many European countries. If a country chooses to leave the European Union, it must be prepared for economic pain. Perhaps France, which has fewer debts and a relatively healthy banking system, still has such a strong voice, but other countries may not have this confidence.

The EU is now at a fork in the road. Although we believe that the disintegration of the EU is unlikely in the short term, here we will discuss the future direction of the EU and its impact on various assets.

    First, the collapse and disintegration.

    The disintegration of the euro and the break between the periphery and core countries of Europe will have a huge impact on the entire European economy. The currencies of peripheral countries after leaving the euro zone have depreciated sharply, while the currencies of core countries may appreciate as a safer asset after short-term adjustments. Bond interest rates will rise, which may cause collective defaults, and real estate will also be hit because consumer fundamentals are not good. At the same time, European stocks are facing greater shocks. In addition, in the current environment, whether the Brexit proposal put forward by the right-wing parties can be implemented smoothly may be a problem. Brexit requires a lot of cooperation and negotiation between the exiting countries and the remaining countries. However, in the international political arena, there are no permanent friends. In the face of former interest partners and present alliance betrayers, Germany may not be able to easily compromise.

    Second, profound reforms.

    The euro area is reforming, establishing an efficient banking system, and forming a euro area fiscal union. But this requires European politicians to resolve many political conflicts. If the reform is successful, a real risk-sharing system can be truly formed in the region. A reasonable regional fiscal policy combined with the monetary policy of the European Central Bank can stimulate economic growth. Only economic growth can give citizens of European countries enough confidence to go to the European Union.

    This may be the best result we can expect. Under this circumstance, a turnaround in the economy is conducive to higher returns on risky assets, and the national debt of core countries as a safe-haven asset may not be so popular for the time being. Correspondingly, the debt problems of peripheral countries may be alleviated, and the spread between their national debt yields and core countries' interest rates will also decrease. The euro will appreciate because of the positive trend in Europe. But the real estate market may be relatively weak due to higher interest rates.

    Finally, keep the status quo.

    In the past seven years, Europe has personally shown us how to get by with "expedient measures". The talk of "EU collapse" in the market has never ceased, but the EU is still moving forward in a state of bumps and bumps. In the future, they may still use this special pragmatism to solve problems by using soldiers to cover water and earth. In particular, the current global re-inflation environment is beneficial for the EU to temporarily alleviate economic problems. In order to win the support of the people, EU institutions may ask countries to suspend welfare reduction measures and make adjustments on immigration issues. In this case, the performance of most assets may remain the same: the yields of core country bonds remain low, while peripheral countries face higher borrowing costs. The stock market may perform better, benefiting from re-inflation and the weak euro, cyclical stocks and export stocks may rise.

    According to our estimates, the probability of the above three situations occurring within three to five years is about 10%, 20%, and 70%, respectively. But if EU member states do not seize the time to carry out deep reforms, the opportunity to maintain the status quo will only gradually give way to the coming of disintegration. Again: People tend to overestimate the changes in the next two years and underestimate the changes in the next ten years.