As the market focuses on Greece and Spain, I believe that attention should be diverted to Germany. After all, Germany’s economy is the largest of the euro zone economies, and is being counted on to help rescue its Mediterranean cousins.
As a result of analyzing German data, and in light of the overall global economic risks, we have moved 15% of the GMG Defensive Beta Fund assets into cash, covered calls and other hedging instruments.
Although I do not view the European debt crisis as worsening, recent data from Germany is giving me additional pause. Specifically:
The manufacturing sector contracted at the fastest pace for almost three years in May
The Purchasing Manager’s Index (PMI), down.
Manufacturing output, down.
The new business index, down.
New export orders, down.
The ZEW survey, tracking investor and analyst sentiment, down.
There were some signs of life in the consumer sector and in consumer spending. But my read is that Germany may succumb. The importance of this cannot be underestimated. Growth in German GDP during the last quarter of 2011 and the first quarter of 2012 made up for the weaker economies in the south, and is frequently cited as the reason the Euro Zone did not slip into a recession.
Should Germany’s economy start to contract, and there are early signs that it is, I believe there is a risk that crisis in Europe could deepen and permeate through the globe. Moreover, should Germany slip into a recession, I believe that the political climate will turn sour and make any check writing by Germany to save Greece or others an almost impossible task.
As we approach Greek elections on June 17, the risks of more turmoil will likely increase, after all there are only two potential outcomes to the election. Either, a moderate and sensible group of parties wins enough votes to form a coalition, or the radical left, led by Mr. Tsipras wins.
In the event that early polls prove correct and the left wins, markets are likely to react harshly. This combined with some weakening data in Germany–the “check book” of Europe–is reason to become more defensive.
Given that market timing is almost impossible, and an exercise we would rather forego, we determined that having some dry powder in these turbulent times is the appropriate course of action. Hopes and prayers of substantial action by the European politicians and bankers that have driven markets higher over the past week are likely to prove nothing more than a hope and a prayer–not an investment strategy we are willing to follow.
