by Dana Weeks
Updated: July 22, 2016
Brian Whitmer, the editor of our monthly European Financial Forecast, talks about the negative sentiment in the European Union following the historic Brexit vote and outlines what to watch for next.
Dana Weeks: Hi, I'm Dana Weeks and welcome to ElliottWaveTV. Today I'm chatting with Brian Whitmer, editor of EWI's European Financial Forecast. Brian, thank you so much for joining us. It is an interesting time: We're close enough to the Brexit results so it is still relevant, but far enough away that we can gain a little bit of perspective. So Brian, in your view, how did the vote affect sentiment towards the EU and sentiment in general, what do you see?
Brian Whitmer: It's really interesting because we've actually seen a bit of a boost in sort of pro-EU sentiment. If we look at Germany, Angela Merkel's approval ratings jumped after the vote. At the same time, ratings for parties like AFD (Alternative for Germany), which is sort of the anti-EU populous party, they sank. So, Merkel represents the establishment, the status quo, the pro-EU approval ratings are up, anti-EU sentiment is down. I think that's kind of an interesting result. Like I said, it's only weeks after the vote; we'll see if it's sustainable or not.
Dana: The focus has been on the United Kingdom and rightfully so. But there are other problems: Spanish elections, Italian banks. What are you seeing in other countries that we should be keeping an eye on from a political perspective?
Brian: Actually, politics-wise, one election that I think is going to be really important is in Austria. What we have here is we're going to get a clear pre-Brexit, post-Brexit look at politics. The Austrian constitutional court just annulled the result of the election in May. In that election, you had the anti-EU, the far-right party, a guy named Norbert Hofer, lose by less than 1 percentage point, so we're going to have a re-run of that election in October. Like I said, we're going to get a real clear indication of sentiment toward the EU pre-Brexit and post-Brexit. The other thing that's interesting about Austria is that Hofer is sort of forming this league of far-right parties that extends to places like the Netherlands, France, Germany and Denmark. And all of these places have important elections coming up. You've got the French presidential elections in April and May of next year. You've got Germany, of course, coming up in October. And also, in Italy, we've got elections coming up in 2018. I think it's going to be super interesting to see how this sentiment plays out over the course of the year and into early next.
Dana So let's turn to the markets themselves. I know you like to use them market as a sociometer (a measure of social mood) and focus on Elliott wave counts in price charts. Is there anything we can glean from the various markets that may shed a bit of light on some of the political outcomes?
Brian: Like I said, it makes sense to me that the pro-EU establishment candidates are sitting comfortably in places like Germany and Denmark where stocks re near all time. It makes sense that anti-EU populous are gaining ground in places like Italy, Spain, Netherlands where stocks are way off their highs. I think it's going to be really interesting to see what happens to the market late summer-early fall, when we have traditionally the weak period for stocks. And especially where the market is early next year when a lot of these elections start coming to the forefront. The further stocks fall, or the lower stocks are early next year when these election campaigns start to heat up, I think the more challenging it's going to be for the establishment, the sitting politicians to hang onto their seats. My hunch right now is that this post-Brexit bump in pro-EU sentiment, my hunch is that it's temporary, temporary reaction to a pretty significant sell off, at least we saw in stocks, right after Brexit, and a huge move in the currency market. People saw that and said, whoa, let's rethink this thing, maybe the EU isn't such a bad idea, after all. Maybe leaving the EU is horrible. I think that's probably a temporary reaction, and we'll have to see what things are like moving forward.
Dana: Okay. Then Brian, just to be clear, what you are saying is that where the market is will help determine the results of the election, it is not the result of the election that will determine where the market goes. Is that the way you think of it?
Brian: Exactly. The market is measuring mood, and in bear markets we have fairly reliable history that shows that bear markets favour anti-establishment parties, political polarization. So I think, if stocks are much lower this time next year, that's going to favour these anti-EU factions of various parties and the opposite is also true. If this is a new bull market and stocks are way higher next year, I think the establishment candidates are going to fare well.
Dana: So let's switch from stocks and foreign exchange to something I know you have been writing about for many quarters: the bond market and the credit market. Talk to us about these markets, what risks do you see going forward?
Brian: As risky as I see the stock market right now, I think the bond market is probably even more dangerous. A lot of people fundamentally understand default risk in the bond market: The borrower can go belly up and not pay on the bond and that's a risk that people understand. I think fewer people understand the risk associated with longer day-to-day. We have investors now that are chasing yield not just by buying lower quality debt, but by buying longer and longer day-to-day. The risk there, especially with long-dated low coupon debt, is that it takes longer and longer to get paid back on your initial investment. This is kind of wrapped up in this concept that I call duration, which sort of measures the sensitivity of a bond price, or a portfolio of bond prices, to a rise in interest rates. So the key feature is that duration in the bond market has been rising, really since 2008, this steady climb, and that represents risk. The longer-dated debt, the lower-coupon debt is much, much more sensitive to a change in interest rates. If we get a small rise in interest rates here, people stand to lose a lot of money.
Dana: So people have been forced out the yield curve in order to get more attractive returns. But this is quite a risky business. All these market and political uncertainties seems to add up to a potentially volatile end of year and 2017. Would you agree?
Brian: I think it's going to be a very interesting time, not just in the stock market, in the bond market, in politics. We've got really this confluence of factors that's coming together here in the latter part of this year and the early part of next year that's going to make for very exciting time in the market.
Dana: Terrific. Thank you as always for your insightful commentary and for your time Brian.
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