Societe General Cross Asset Research publish a Special Report titled ‘How to survive the balance of payments crisis,’ and propose investment strategies based on the analysis of external imbalances in 25 developed and 23 emerging countries.
SocGen place special emphasis on external imbalances, saying they have “huge market implications.” Balance of payments dynamics played a huge role in the Eurozone debt crisis and in the turmoil unleashed in the emerging markets after the Fed’s hint to taper off QE3.
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SocGen examined the external accounts of a country by looking separately at its (1) current account, and (2) net international investment position (IIP). In the words of the analysts, (1) is a ‘flow’ approach, and (2) is a ‘stock’ approach, and both provide different insights into the country’s economics.
It is possible that a country’s current account could be improving but its net IIP remains weak. What matters is an assessment of which has been priced in by the markets.
The situation in Europe
According to SocGen, imbalances in the Eurozone periphery and in Central and Eastern Europe have substantially corrected, while in France external imbalances have been moderate, and in fact, are expected to correct in forthcoming quarters.
Recommendation for France
SocGen recommends investing in the CAC 40 and long-term 10-year OAT bonds (Obligations Assimilables du Trésor). “After almost a decade of loss of competitiveness, labor cost increases have stabilized in France compared to Germany since 2007. In fact, since 2011, wages have increased faster in Germany than in France.” The trade idea: Long CAC/short DAX; Long 10y OAT/short 10y Bund.
France is about to reverse the chronic deterioration in its external accounts, and is expected to shrink the deficit in its current account with Germany, as shown below.
France has already reformed the labor markets and pensions, and may now reduce corporate taxation in an effort to improve business competitiveness.
The above factors set up a case for investing in French bonds and equities. SocGen expects a tightening of the OAT-Bund spread, and the CAC will likely outperform the DAX.