WHAT ARE YOUR VIEWS ON THE EUROZONE DEBT CRISIS?
A lot of issues are now coming to the boil in the eurozone. It is now evident that the problems in the periphery are increasingly beginning to impact the core. The fact that sovereign bond yields have moved up inBelgium,AustriaandFranceis a worrying development that will ultimately put more pressure on the ECB’s bond purchase programme. We have already seen considerable purchases to support the peripheral nations; these purchases are draining reserves from the wholesale inter-bank lending market. This, in turn, has deleterious consequences for the wider real economy via reductions in bank lending and introduces the prospect of a second credit crunch.
So far, the ECB has been buying bonds on a sterilized basis using its balance sheet to fund purchases, meaning there is no increase in the money supply. With the need to support an enlarged group of sovereigns, the ECB may be forced to consider increasing the money supply to allow it to make unsterilized purchases of bonds. This policy change to quantitative easing has significant political barriers to overcome, however, principally in the form of German opposition.
The theme that has been driving bond markets in 2011 has been the reappraisal and re-pricing of peripheral sovereign bond debt. As we move into 2012, I think investors need to keep a close eye on the bond yields of Belgium, Austria and France. In 2012, the theme driving markets may well be the reappraisal of core, AAA rated sovereign debt. We have started to see the beginnings of this process and the markets are ahead of the rating agencies once again.
ARE WE ENTERING INTO A FINAL PHASE OF THE CRISIS?
Given we are talking about AAA sovereign nations now becoming involved, this has to be the final phase of the crisis, simply because there is nowhere else for contagion to spread. The wave of deleveraging, and the reassessment of risk that accompanies it, will have washed right through our financial economy. While 2012 is likely to be a troubled year, the attendant volatility that we see in financial markets should also mark the last down-leg of this crisis. The speed at which the crisis has moved from Italy to Spain and now core Europe has been alarming, but it also suggests a crescendo. As I alluded to before, the evolution of the crisis path now suggests a tipping point at which quantitative easing by the ECB becomes palatable to Germany as the only option that avoids a eurozone break up. The path between the inconceivable and the inevitable has now become very short.
HOW SHOULD INVESTORS BE POSITIONING THEMSELVES?
Clearly, the cautious stance that we have been taking in our multi-asset funds continues to be warranted. Within equities, investors should focus on high-quality, defensive companies with stable and reliable earnings streams, which pay high and sustainable dividends. InEurope, dividend yields are considerably in excess of their 15-year average and there are a number of equity funds which are targeted towards this particular income-yielding section of the market; the income offers a measure of protection to investors against further market volatility. These companies are typically large, robust household names like Unilever, which may well prove to be a relatively safe place for many investors to park some of their cash, when you consider the stresses that the banking system remains under.
Lastly, in a geographic sense, let me say that the long-case for emerging markets is intact and I very much believe we are in a ‘two-speed world’ in economic growth terms. In the short-term, however, we know from experience that when risk sentiment deteriorates, equities are treated in an indiscriminate fashion and sold off en masse. While these markets do not offer near-term respite from the problems in the eurozone as equity correlations are likely to converge once again when volatility becomes heightened. However, when you consider their superior fundamental economic ability to recover, and the likely speed at which they can recover from a crisis centred on Europe, and the fact that their issues are cyclical in nature rather than structural, then the case for investment in emerging markets is robust on a medium to long-term view. I think investors will certainly want to be exposed to emerging markets as we emerge from this crisis.
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