More of the same
Author: Cathy Dixon, investment director
This article has previously appeared in the Irish Times in November 2011
Headlines remain dominated by the Eurozone crisis. Just as we think some sort of resolution has been reached, more problems blossom forth. Last week was no exception: after the drama from Greece which ultimately resulted in Mr Papandreou’s stepping down and a new coalition government in place, the emphasis shifted to Italy, where Mr Berlusconi has also been compelled to step aside. While this might look like more of the same “Euro-angst” in reality Italy is a very different proposition to Greece: it is the world’s eighth largest economy and a founding member of the European Union. Yet its debt mountain has reached scarily large heights and funds required to save it would surely be beyond anything amassed by Europe’s crisis managers. The solution to this is not clear: both leaders have been replaced by technocrats: unelected but trusted within the EU to deliver the measures deemed necessary.
Once the euphoria of their appointment dies down, it should start to become apparent just how great a task they face. Italian government debt saw 10-year rates soar last week to over 7.5%, a level generally regarded as unsustainable over the long term. We have also now seen short term debt yield rise to higher levels than long term debt: this implies the market is expecting a severe financial crisis in the near future, an expectation endorsed by the recent experience of Greece, Ireland and Portugal. A worrying thought indeed.
Just how does this affect us? The stock market appears to have reacted with surprising equanimity. In August when the Greek problems first emerged the FTSE 100 plunged to 4900; now the situation seems to have worsened the market is around 5500. This appears somewhat illogical (but when was the market ever logical?) and implies a disconnect between the equity and bond markets. The effect on global UK companies could be significant. Europe is our largest trading partner by some margin, thus it is unlikely that major companies will escape unscathed. The likely outcomes do not look particularly inviting. Firstly if there is a break-up of the euro, a systemic banking crisis and global recession is likely to follow; the second option is commitment to a horrendous level of austerity, which is also likely to be followed by recession and civil unrest. The third possibility is a round of ECB-driven money creation and sovereign bond-buying on a massive scale, which also raises huge uncertainties. None of these offer much encouragement.
Overall it is clear that the market is facing much uncertainty. Although our banks look better capitalised and less exposed than their European counterparts, they are unlikely to escape unscathed, which in turn will have a knock-on effect on UK lending in general. We are once again seeing the gold price creeping up as investors turn to it as a form of insurance, a sure sign of fading confidence.
One of the few guarantees is that we are living in interesting times. There are still opportunities, but it remains hard to second guess the outcome. The constant message is to stick to diversification and fundamentals.
For further information, please contact:
Cathy Dixon
Director
Investment management
T: 028 9072 3000
This does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise. Investments carry risk and investors may not receive back the amount invested. The views expressed are those of the author and not necessarily of Cunningham Coates Stockbrokers.
Cunningham Coates Stockbrokers is a trading name of Smith & Williamson Investment Management Limited. Authorised and regulated by the Financial Services Authority. Registered number 131816.