ANALYSIS: One of the main reasons Britons voted to leave the EU — there were several based on exit polls — was they did not like the unelected officials in Brussels increasingly influencing their future. I wrote last week that this is likely the beginning of the end of the EU as it exists today. And I expect it could take five years or longer to fully play out, though it could be much sooner.
Elections in Italy (Oct. 2016), Netherlands (March 2017) and France (April 2017) in particular could see a rise in right-wing populism that is increasing in most countries including “Trumpism” in the U.S.
The thought that maybe they don’t have to listen, maybe Scotland could veto, or maybe have another referendum until they get the results they want would only serve to infuriate the masses even more. A politician that did not support the results of their electorate would be crucified and would likely be a career-ender. I see any of those “redo” efforts as a non-starter.
Markets do not like uncertainty, and over the next year, there will be lots of uncertainty around how all this will play out. Marine Le Pen, leader of the far right in France, will be campaigning hard for an April 2017 bid and no doubt will take the anti-EU route as she has already demonstrated.
The old adage that Mr. Market inflicts the most amount of pain on most of the people suggests that the bulls need to feel some pain and that does not happen until new lows are seen. The first area that we need to follow is the European banks.
There are a few ETFs investors can watch: EUFN, HBG, FHB.
The STOXX 600 banking index (tracked by EUFN) is close to making lower lows than after the PIIGS crisis. New lows here would suggest the rest of Europe likely trades down to the 2011-12 lows too.
The overall STOXX 600 index probably has to fall 10-15 per cent more than it has already for the bulls to feel enough pain to trigger a capitulation. The closest ETF in Canada that would track this index is the iShares XEH, but the history does not go back to 2011. This ETF would need to fall to about $15-15.50 from Friday’s close to begin to come close to support levels.
And finally, we look at the fundamentals of earnings per share for the STOXX 600. The top line in the chart in the above video shows analysts’ forward earnings estimates and the bottom shows actual trailing earnings. With all the QE and zero interest rates, there is no stimulus and even lower rates will not likely help.
The ECB is out of bullets and the bulls need to feel some pain so that Mr. Market is satisfied. If you need to be invested because you need your dividend, the best way to do that for now is with ZWE (BMO Europe covered call hedged to C$) with a yield over 7 per cent. It will still fall, but the yield should help.
The upside once the dust settles could be significant. Switzerland has operated in a single market outside the EU and is thriving save for the strong franc that does impact some of their trade with Europe.
This is just the next thing the markets have to deal with, and in my humble view, Europe will emerge stronger, as the current model is clearly not working. Does the EU hold together or not? The answer is now simple: Will Germany take on all the debt and be responsible for all of it? Nein!
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