“Deflation In Europe Is Just Beginning”… And How To Trade It
The problem with deflation is that minuscule levels of GDP growth are unable to drive unemployment lower and unable to prevent debt ratios from grinding higher and posing a larger threat down the line. Mathematically, as primary budget balances are lower than the difference between real GDP growth and real interest rates on public debt, the debt/GDP ratio is set to rise, from already alarming levels
The good side of the story is that we believe that the ECB and fiscal authority will be forced into further action from here, in an attempt to avoid a fully-fledged debt crisis and a long period of Japan-style depression.
Will ECB be allowed to engage in non-conventional monetary policies, their version of QE, pushing equity and bonds higher in Europe, compressing spreads and yields further, within the next 6/12 months?
The impact on equity we expect is one of melt-up, at least in a first phase, pushing them into bubble levels, not supported by fundamentals but rather by the mix of lower yields, zero inflation rates, modest economic growth. Against this backdrop, we believe that the activism of the ECB can lead into 20%/30% upside for equities in Southern Europe, especially in the financial industry. Our favorite markets are Italy and Greece, which we think have the potential of being best performers in the next 12 months