Paris is Prologue, by Worth Wray

From Worth Wray at evergreengavekal.com:

“Europe only succeeds if we work together.”
~ Angela Merkel, Chancellor of Germany since 2005

SUMMARY

– The recent attacks in Paris evoke strong emotions for many people, but investors need to look through those feelings to the short, medium, and long-term implications. I believe Paris may mark an important turning point for Europe and the global business cycle… but for different reasons than you may think.

– The immediate impact on France’s economy will be minor and short-lived as long as it proves to be an isolated incident. There are significant downside risks to economic growth if terror attacks in Europe become the new normal.

– Europe’s Muslim population faces an unemployment rate around 50% compared to the EU average of 10% and xenophobia is rising after the Paris attacks. From that perspective, Europe is becoming a breeding ground for radical Islam.

– As refugees flock to Europe from Middle East, the foundations of modern Europe are breaking down. Walls, fences, and security checkpoints are going up all over the continent and countries are becoming more isolated from one another.

– While Angela Merkel’s leadership has proven invaluable in preserving the Euro Area over the last decade, her position on accepting refugees is incredibly unpopular in Germany and across Europe. Her political weakness in the wake of the Paris attacks now puts the European establishment at greater risk just as anti-establishment parties are on the rise and a number of political crises are emerging in Spain, Portugal, and Greece.

– With no politically palatable option for restoring stability in Syria and Iraq, there is no end in sight for Europe’s refugee crisis. And if there is no end in sight for Europe’s refugee crisis, the xenophobic shift toward anti-establishment parties can only escalate from this point forward.

– The European Central Bank has no choice but to extend and expand quantitative easing. This will weigh on the euro (likely bringing EUR/USD from $1.06 today to well below $0.90) at the same time the Federal Reserve is driving the US dollar higher.

– The main investment takeaway here is that more policy divergence is on the way between the United States and the rest of the world, meaning a stronger US dollar, lower commodity prices (although energy prices could spike on Middle East instability), and another wave of panic for emerging markets. It also means more pressure on Japan to follow suit in an escalating currency war and on China to allow a market-driven fall in its currency.

– There is a chance that the slow disintegration of Europe will drive more capital onto US shores, boosting valuations and fueling a blow-off top in the US equity market; but beware global shocks and take any rally as a chance to get defensive.

To continue reading: Paris is Prologue