The € is Becoming a Funding Currency

I spent a few days in London last week, meeting with investors and discussing my book. I also managed three separate TV appearances. I can tell you that if the € sovereign debt crisis appears to dominate the news in the U.S., it is an all-consuming obsession for the financial media in the UK. It is naturally more impactful on Britain, and the jingoistic response of the popular media to Prime Minister Cameron’s exercise of his veto over Treaty changes showed how shallow is the support in Britain for the European project. I’m sure if there was a way to shift Britain 1,500 miles to the west it would more accurately reflect the country’s center of gravity between European liberalism and U.S. mercantilism.

But wherever you sit, Friday’s EU summit was yet another all-too-small step towards finding solutions to the problems of too much European sovereign debt. The markets are now left to wait and see if the ECB will find enough to like in the commitments of the other 26 nations towards fiscal discipline so that it can become a significant buyer of high yielding sovereign debt. One has to assume they will do so if needed – sufficient private buyers are not yet there, although over the next 2-3 years the Carry Trade could become a source of recapitalization for European banks desperately in need of such. 7% Italian yields funded at 1% could replenish the retained equity of banks for a considerable time. It’s not a trade we would do ourselves, but it could plausibly draw substantial capital in the months ahead.

Indeed, the growing differential in Real GDP between the U.S. and the € zone looks set to be 2.5% in 2012 and could easily reach 3% if Europeans follow through on promised austerity while the U.S. delays such and extends the payroll tax deduction. The € is becoming a “funding currency”, the disrespectful moniker attached to a currency facing an extended period of low rates and little prospect of moving higher. Borrowing in € is looking increasingly like a cheap source of funding – after all, European sovereigns have been doing so for years with reckless abandon (hence the present crisis). The ECB is likely to keep rates low and in considering the solutions, whether they stay on the present course of  employing fiscal drag, utilize an increase in inflation or stumble into a disaster, it would seem that most plausible paths for the € are lower. It’s frankly part of the solution, to further stimulate exports and devalue the real value of debt owned by non-€ investors.

We think it’s one of the better trades available, but in combination with a long equities portfolio is becomes quite compelling. Stocks are reasonable long-term value and are compelling versus fixed income. A higher € would almost certainly be accompanied by higher equities and an altogether more friendly investment outlook. It’s not obvious how we’ll get there, but it’s certainly possible. The big issue restraining equities is the €. So borrow the € and buy US stocks.

As a result we remain invested in U.S. equities. Our biggest position is Kraft (KFT) an attractively priced name that provide exposure to global GDP in combination with their own positive story. KFT has seen almost 7% organic revenue growth through the first 9 months of 2011 and more than 5% of that has come from pricing, so they’re clearly able to push increases through the pipeline. They continue to enjoy operating margins of 12-14%. The Cadbury synergies are coming through, both in sales of Oreo cookies in India across Cadbury’s existing distribution infrastructure and through sales of Cadbury’s chocolate in South America where it had relatively small penetration. KFT’s break-up next year into a global snack business and U.S. grocery business should unlock additional value for investors, and at 14X next year’s consensus earnings with 11% YOY EPS growth we think valuation is not excessive.

We continue to like Aspen Insurance (AHL), trading at 60% of book value in an industry with reduced capacity given a series of reinsurance payouts over the past year (Japanese earthquake and so on).

We are long stocks such as these in our Deep Value Equity strategy, and in our hedge fund maintain long equities with a short € (long EUO).

Disclosure: Author is Long KFT, AHL, EUO

Print Friendly, PDF & Email

Important Disclosures

The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy,  completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments.  Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)

This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r

Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.

All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.

Past performance of the American Energy Independence Index is not indicative of future returns.

Print Friendly, PDF & Email
0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.