Saturday 26th July 2014
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FRIDAY ANALYSTS TICKER: July 25th 2014 - According to Adam Cordery, global head of European fixed income, Santander Asset Management, and fund manager for the Santander Euro Corporate Short Term and Euro Corporate bond funds, “Pricing of risk assets doesn’t offer much of a margin for error at the moment. And now Europe is starting to go on holiday, market liquidity may get poorer than normal, and any buys today may well have to be holds until September. It is always interesting to note what yields are required to attract clients to financial products. Twenty years ago, bond funds offering yields of 10%+ could generally attract lots of client interest very quickly. However as rates have come down over the years, so the yields clients demand have fallen. Now 4% seems to be the new 10%, he say. Cordery thinks that unfortunately, investors often want today the yield/risk mix that was available last year, so the products that get launched, sold and bought in size may be more risky than people think. “Products with 4% yield will sell well today, but to get to a 4% yield in Euro you need to invest in a portfolio with an average rating of single-B, and that is far from being risk-free. I get the impression the conventional wisdom today is to think that interest rates must surely go up soon and the main risk to bond portfolios is an increase in bund yields. Because of this many investors are buying short-duration products and floating rate notes, perhaps viewing them as a safe choice, almost like cash. It is possible however that these products may yet prove to have a considerable sensitivity to changes in credit market spreads and/or bond market liquidity, and may prove to be no protection at all.” - Commenting on the RBS share price jump, Dr Pete Hahn of Cass Business School, says “It's hard to tell whether the RBS share price jump today is more about relief or optimism. The former is about fewer fines, fewer losses on loans, and fewer costs in a shrinking business and possibly dividends for shareholders. And there's the rub, owning shares (as opposed to interest bearing debt) should be about optimism and long-term growth in dividends. But from a shrinking business? Few would argue that RBS' retail and corporate bank had efficiencies to be gained and cash flow that might be converted to dividends; yet like most banks, RBS' cost of equity remains stubbornly and appropriately above its ability to provide a return on that equity. For shareholders, current improvements should mean dividends in the medium term but a recognition that RBS may lack any merit for new investment and delivering any long-term dividend growth - not good. While many large retail banks are getting safer, in some aspects, and we often speak of them in terms of moving toward utility type models, banks take risks, are cyclical, face competition, have new business challengers, and are simply are not utilities. Investors shouldn't get ahead of themselves here.” - According to the monthly survey held by the central bank of Turkey, the country’s capacity utilization (CU) rate declined slightly to 74.9% in July from 75.3% in June. Meanwhile, seasonally adjusted (SA) CU also declined to 74.3% from 74.7% in June, writes Mehmet Besimoglu at Oyak Yatirim Research. As for manufacturing confidence, the index declined to 109 from 110.7 in May. On SA basis, the index also edged down slightly to 106.4 from 107.2. SA capacity utilisation was broadly stable in 1H14, averaging at 74.7%. This is the same level with the 2013 average. Despite the political turmoil and volatility in financial markets, activity has been relatively resilient. Export recovery & government spending supported production in 1H. Following the elections, public spending relatively decelerated. The turmoil in Iraq also decelerated export recovery from June. Nevertheless, we still expect 3.5% GDP growth in 2014, writes Besimoglu.

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The European Review

By Patrick Artus, chief economist at Natixis

The core reason for asymmetry between the German and French economies: corporate profitability

Friday, 25 May 2012 Written by 
The core reason for asymmetry between the German and French economies: corporate profitability The main explanation for asymmetry between the French and German economies is that in France, companies’ production capacity is unable to keep up with domestic demand, whereas in Germany it is growing faster than domestic demand. This difference is related to corporate profitability: high and rising in Germany, but low and falling in France, which is limiting French companies’ investment capacity. There are two plausible causes for the profitability gap between German and French companies: the higher level of product sophistication and diversification that gives more pricing power to German companies; and the nature of labour market negotiations, where the link between the labour market and the economy is much stronger in Germany than in France. Yet – if no new economic policies are introduced to improve the profitability of French companies – it is more than likely that the country’s economic situation will not improve. http://www.ftseglobalmarkets.com/

The main explanation for asymmetry between the French and German economies is that in France, companies’ production capacity is unable to keep up with domestic demand, whereas in Germany it is growing faster than domestic demand. This difference is related to corporate profitability: high and rising in Germany, but low and falling in France, which is limiting French companies’ investment capacity. There are two plausible causes for the profitability gap between German and French companies: the higher level of product sophistication and diversification that gives more pricing power to German companies; and the nature of labour market negotiations, where the link between the labour market and the economy is much stronger in Germany than in France. Yet – if no new economic policies are introduced to improve the profitability of French companies – it is more than likely that the country’s economic situation will not improve.

The economic asymmetry between France and Germany

The main reason for economic asymmetry between France and Germany, which also explains the differences between their current account balance situations, is the ability of companies to build up production capacity to meet domestic demand.

Indeed, domestic demand in France has increased much faster than GDP meaning that its inability to meet excess demand through domestic production has cost them potential economic growth. And its production capacity for industrial products in particular has been unable to keep up with domestic demand. This is in stark contrast to Germany, however, where domestic demand is actually weak relative to supply.

The role of corporate profitability

A key explanation for the differences between German and French companies’ investment capacity is corporate profitability, particularly in the manufacturing industry. Indeed, corporate profitability has been growing in Germany but declining in France since 2000. This is because, unlike in Germany, French companies are faced with cost increases that exceed price increases, particularly in the industrial sector. Furthermore, French companies have been unable to pass on increases in production costs to consumers, explaining the long-run decline in profitability since 2001.

Indeed, the low profitability of French companies is an obstacle to investment that German companies are not lumbered with. Furthermore, German firms’ self-financing rate (the ratio of savings to fixed capital) essentially exceeds 100%, explaining why there is a faster rate of productive investment in Germany. Meanwhile, the greater capacity for investment in Germany will be amplified if it becomes more difficult to obtain credit, which is likely to be the case in France due to the impact of new prudential rules for banks.

Causes of low corporate profitability in France

There are two major causes for French companies’ poorer profitability:

1. Less sophisticated industrial products

The fact that French industrial companies are unable to pass increases in production costs on to consumers shows their weak pricing power and the low level of product sophistication. Demand for French products is therefore price sensitive, which is not the case for German products, and explains why France’s export market share fell when the euro appreciated between 2002 and 2008 yet Germany’s did not. Meanwhile, it could also be said that France is stuck in a vicious circle: the low product sophistication of French companies reduces their profitability, which reduces their ability to invest and enhance the quality of their products.

2. The nature of labour market negotiations

The rise in unemployment and the weakness of activity has caused a significant slowdown in wage growth in Germany. However, this has not occurred in France, where wages have been less sensitive to the performance of the economy. Since wage costs remain high, it is more difficult for French companies to enhance corporate profitability after periods of weak growth.

Indeed, profitability remained low in France from 2003 to 2007 and from 2010 to 2012, yet improved in Germany. So labour market negotiations in France seem to favour "insiders" (employees who have kept their jobs) instead of encouraging firms to hire new staff. But in Germany it is easier to negotiate the wages of existing employees and therefore to recruit new staff.

Which economic policy approaches should be used in France in order to address these issues?

Government policy should seek to boost corporate profitability by:

  • Lowering labour costs to restore profit margins for French companies and to boost investment. This can be achieved through tax reforms that reduce the weight of welfare contributions;
  • Helping French companies to invest more despite their low self-financing rate. This could include government intervention such as public-sector funding or loans via state-owned banks, as well as through the development of a large corporate bond market;
  • Helping companies to improve product sophistication through government research grants, government contracts for technological products, and offering support for new industries: digital, energy, etc.;
  • And finally, by changing the nature of negotiations between unions and employers in France to ensure the employment component is taken into account in negotiations.
Patrick Artus

A graduate of Ecole Polytechnique, of Ecole Nationale de la Statistique et de l'Adminstration Economique and of Institut d'Etudes Politiques de Paris, Patrick Artus is today the Chief Economist at Natixis. He began his career in 1975 where his work included economic forecasting and modelisation. He then worked at the Economics Department of the OECD (1980), before becoming Head of Research at the ENSAE. Thereafter, Patrick taught seminars on research at Paris Dauphine (1982) and was Professor at a number of Universities (including Dauphine, ENSAE, Centre des Hautes Etudes de l'Armement, Ecole Nationale des Ponts et Chaussées and HEC Lausanne).

Patrick is now Professor of Economics at University Paris I Panthéon-Sorbonne. He combines these responsibilities with his research work at Natixis. Patrick was awarded "Best Economist of the year 1996" by the "Nouvel Economiste", and today is a member of the council of economic advisors to the French Prime Minister. He is also a board member at Total and Ipsos.

Website: cib.natixis.com/research/economic.aspx

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