Brexit was just the start, says hedge-fund manager Hugh Hendry.
In a monthly report to clients, the outspoken investor and managers at macro-oriented Eclectica Asset Management paint a gloomy picture of political uncertainty and policy impotence that could see the European Union splinter apart.
The fund’s “main conclusion is that by doing the unthinkable and actually voting to leave, Brexit substantially increases the likelihood that other members of the European Union will also seek to break away,” Hendry and associates wrote. They pointed back to the gold standard, noting that just two years after the U.K. similarly rejected the policy regime in 1931, there were just 12 members left out of the original 45.
Over in the U.S., a victory by Republican challenger Donald Trump would be hailed as a triumph by those who cheered Brexit. In Europe, a crucial constitutional referendum could be rejected in early December, while next year’s French election is likely to see major party candidates tack toward the anti-European, nationalist agenda of Marine Le Pen, they said. And that will be followed by elections in Germany, where anti-immigration sentiment could endanger the “once unassailable” Chancellor Angela Merkel.
Meanwhile, European rules handcuff efforts to shore up European banks which remain “dangerously undercapitalized,” they wrote.
Hendry’s profile rose when his fund posted a 31% return in 2008, Bloomberg noted, with the Scottish fund manager garnering even more attention after several TV appearance, including one in which he offered to tell told Nobel laureate economist Joseph Stiglitz about the “real world.” Hendry’s performance has seen variation since then, according to news reports, with the CF Eclectica Absolute Macro fund down 3.7% in the 12 months ended Sept. 30, according to Citywire.
It isn’t just politics, monetary policy is a mess, too, argued Hendry and company. The European Central Bank has little choice but to keep rates extremely low in an effort to foster inflation and fix the economy, but that adds to the woes of the banking sector, which threatens the economy.
This conundrum illustrated by the ability of European banks to outperform the stock market in September and early October in response to a modest steepening of the continental yield curve, they wrote.
The yield curve plots the yield on bonds across maturities, from the shortest to the longest. A divergence in rates is said to be a steepening of the curve.
“Put simply, keeping rates low enough to fix the economy under the current framework seems to consign the banks to the dust heap of meager earnings in perpetuity. But any steepening of the curve sufficient to raise bank profitability would tighten policy in the real economy, kill off any nascent recovery and condemn the continent to further penury and the resulting surge in populism that a lack of economic hope engenders,” they wrote.
And it’s likely to get worse. Easy monetary policy had been the only thing “holding it all together,” they said.
The managers at Eclectica argue that talk of a “tapering” of the ECB’s bond-buying program is “absurd,” but that it appears “monetary zealots from the insular German or Austrian schools” are gaining the upper hand over the formerly bold ECB chief Mario Draghi, they said. Meanwhile, European governments appear focused on “fiscal rectitude, leaving little room for stimulus.
“Without appropriate monetary policy, fiscal policy or bank rescue as an option, all the EU has left is fear to hold it together. It will inevitably buckle if it replaces the carrot with the stick. And so we fear a storm is coming,” Hendry and company wrote.