Our Burning Issues panel feels that Europe is in better shape than many seem to think. And that the prospects for a bounce may already be in place
You won’t have missed the fact that rather a lot seems to be hanging on the fate of the negotiations over Greece’s debts. The new prime minister Alexis Tsipras and his finance minister Yanis Varoufakis have argued hard for €315 bn of debt concessions, against stiff German opposition, but as we went to press both sides appeared to be seeking compromise. That’s good.
But, assuming that the ECB does succeed in formulating a “debt swap” deal that will satisfy all sides (as distinct from a write-down), will that be the end of the current uncertainty, or will it simply paper over the problem? We asked our panel of experts for their views on a fast-moving situation.
· Special thanks to this month’s respondents:
· Jaisal Pastakia, Investment Manager at Heartwood Investment Management
· Tom Elliott, International Investment Strategist at deVere Group
· Dawn Kendall, Senior Bond Strategist at Investec Wealth & Investment
As of early February, the ECB’s announcement of a €1.1 trillion quantitative easing programme seemed to have been generally well received by the equity markets, with early worries about a Greek default being largely outweighed by optimism about better growth prospects and easier export markets. Can this optimism continue?
Yes, we believe this optimism can continue. European equities remain attractively valued relative to other developed markets, given the tailwinds associated with a weaker euro, monetary policy stimulus, a lower oil price and operational leverage. We have seen an improvement in economic data trends of late, albeit from a low base, but they put first quarter growth on a firm footing.
It should be noted that the eurozone is a more stable region than this time three years ago, when the cost of financing ten-year Greek government bonds was around 30%. The eurozone has come a long way since those dark days! Financing costs for Spain, Italy and Portugal have fallen dramatically to more sustainable levels. Unlike in previous crises, yields for those countries have been well supported and not blown out, amid the frenzy and speculation of ‘Grexit’ headlines. Greek debt financing is also more stable than a few years ago. Since the bail-out agreements, the majority of Greek government debt (at least two-thirds) is owned by either the European Union or the IMF, limiting market liabilities to the private sector.
I believe that the positive effect of the ECB’s QE program will outweigh the negative effect of the Greek crisis…eventually. This is because the most likely scenario is still that -after several late-night crisis meetings- Athens will win a slight adjustment to the debt structure which will push near-term capital repayments into the distant future. Enough to allow Syriza some dignity, but not enough to give encouragement to populist parties elsewhere.
Yes, the QE programme announced by the EU anticipated the Greek election and was enough to satisfy markets. It is also open ended, and so the gate is left wide open for more to boost inflation. Remember inflation kills debt – so it will be good for over indebted countries.
Speeches made last week did contain some interesting concessions which shows that the government are willing to at least discuss a compromise – unlike the ECB which is taking a very firm stance. For example, minimum wage over 4 years; and all re-hirings to be fiscally neutral. We have been given information that there is an expectation that the Piraeas privatisation can go ahead as some form of Public-Private Partnership [PPP] and potentially a chance for a deal. Small stuff, but moving in the right direction.
On the flip side, there is a risk that they will call a referendum on Euro exit and this will mean that they will try to cause as much collateral damage as possible in doing so. The impact of this is difficult to quantify.
Regardless of the eventual outcome of the Greek talks, would you say that the equity markets have fully priced in the risk? Or is there any merit in the argument that the Eurozone is looking unusually attractive in the event of an easy settlement?
Investors do need to be aware of the risk talks failing, and of a Greek exit from the euro. This will destabilise the capital markets of other weaker peripheral countries as speculation mounts as to who might be next to leave. The very concept of an exit door to euro membership may lead to a permanently higher risk premia being applied to non-core euro zone government bonds and equities.
Euro zone stock markets are cheaper than the US market, and have received large investor inflows over the last month in anticipation of a QE-led rally (which I think will continue). But the market is not looking ‘unusually attractive’ when other factors are considered, such as the risk of further Russian aggression in neighbouring countries and the risk of a Greek euro exit.
From an asset allocation perspective, Europe is looking cheap. With the potential for currency weakness, this is good for exports and therefore good for economic activity.
Markets have gyrated a lot since Syriza’s election on talk of debt swaps, anti-austerity, and the ECB/German stand-off. We agree with market consensus in expecting a balanced compromise. However, it won’t be an easy settlement and we can expect more market volatile markets as events move quickly. We don’t believe the markets are fully priced for the scenario of a drawn out and messy Greek exit from the euro, which would add to market stress.
The left-wing victory in Greece has emboldened anti-austerity sentiment among the populations of other European countries, notably Spain – but also a careful distancing from their respective governments, worried about unemployment, investment and the implications for bond markets. Can the politicians hold the line?
With an upcoming election in December, focus is placed on Spain where the anti-austerity party, Podemos, has enjoyed a surge in support since being founded in January 2014. The most recent polls suggest that Prime Minister Rajoy’s government is neck and neck with Podemos.
While it is too early to predict an outcome, we expect the voice of moderation to prevail based on the performance of the Spanish economy in 2014. It has been a rising star amongst the largest four economies in the eurozone. Final fourth quarter GDP data in Spain rose 2.0% year-on-year, manufacturing data has been healthy, and the unemployment rate is turning over from high levels. If this momentum can continue, the incumbent government should build its support base.
Finally, if Syriza fails to restructure the Greek debt programme and relax the conditionality surrounding it, then support for the anti-establishment movement might fritter away.
The Irish have a particularly strong claim to have been treated unfairly by Brussels. After all, its bailout loan was used to repay German and French creditors who had bought unsecured Irish bank debt. What does ‘unsecured’ mean, if not that creditors risk walking away with nothing in the event of a bank failure?
However, the Portuguese, Irish and (now, especially) the Spanish governments are hostile to the Greek government’s attempt to renegotiate its bailout packages. They see their policies of enacting Brussels-led austerity and repayment of loans as proof of their ability and willingness to play by the rules, and the reason why their borrowing costs have returned to pre-crisis levels. They are aware that more populist politicians will take heart from any gains made by the Greek government, and will offer promises of cuts in taxation and increased public spending irrespective of the response from Brussels and of the bond markets.
Podemos is gaining traction, but it is a very young “pressure group”. That said, given my comments above, if the Greeks call a referendum on Grexit then the ripple effect could be significant. Europe is tired of austerity but sadly, the policy from the centre (EU and ECB) has been mistimed due to structural issues and lack of centralised control over fiscal policy in nation states.
If nothing else, Greece has succeeded in driving France and Italy off the front pages recently. Will it stay that way?
Greece has gone quiet in the last few days – the reasons why are that there are more pressing geo political issues playing out. Ukraine is geographically close to Germany and she is right to be concerned at the muscular nature of Putin’s actions. When all is said and done, Greece is a small, containable issue from an economic standpoint but politically, small things can have a big impact. Such is the nature of these things.
Potentially, yes, as France and Italy are making incremental progress with reforms. The French government has been forced to adopt a more pro-business stance: for example, making the labour market more flexible and allowing Sunday trading. More progress has been made in Italy on labour market reform, while electoral laws are being implemented to make the passage of reform easier. Clearly, more needs to be done but these early signs are encouraging, particularly in Italy. We have been impressed by Prime Minister Renzi’s leadership in holding together both his party and the coalition government – a feat not to be understated in the fragmented pool of Italian politics!
If my base case scenario comes about, and the Greeks and Brussels agree to a very modest compromise on debt repayment and economic reform measures, the structural problems of France and Italy will re-appear as key problems facing the euro.
The French government has recently reminded its euro zone partners that it is a sovereign nation and therefore cannot be bound by budget deficit agreements, which goes against moves to build fiscal union to strengthen monetary union. Italy’s problem is not with a budget deficit, but the sheer size of its historic debt after decades of over-borrowing and weak economic growth. Both struggle to instigate the type of labour reforms being urged on Greece. These are much larger economies than Greece, and pose long term risks to the euro project as they resist closer economic union and shared fiscal policy making with the core euro zone block.