Market Microscope

James Davies Investment Research Manager

A Hell(enic) of a difficult situation

Watching the Greek debt crisis unfold is a little like being in an accident, where time seems to slow down and the outcome seems inevitable and painful.

It is a near impossibility that Greece will not default on its debt obligations at some point in the next 2 years. The most likely outcome is a "restructuring" of some kind - possibly allowing a deferment of interest payment to creditors. The European Central Bank (ECB) is essentially playing for time.

Their hope, which is no doubt shared by the International Monetary Fund (IMF) and other central banks, is that bailing out Greece now, gives other Southern Eurozone countries (and Ireland) time to sort out their own parlous financial situation and, importantly, European banks time to put measures in place to ensure there is limited contagion of bad Greek debt through the wider banking system. They may pull it off. Economic growth is a rosy 3.5% in Germany¹ and remains robust in many other parts of Northern Europe. The longer term future of the Euro and indeed the wider European project hangs in the balance. It is worth pointing out, however, that the Euro is under threat because member states were allowed entry when they shouldn't have been. Had the entry requirements been stuck to; and numbers not fudged we (they) wouldn't be in this situation. As is often the case, it's now up to the politicians to get us out of the mess that politicians got us into!

Another reason for our favourable long view of equities is our concern over certain other asset classes. Chief amongst these is an overall negative short view of fixed interest assets like government bonds. In the current uncertainty the attractiveness of ´safe haven´ assets like UK Gilts and US Treasury stocks is undeniable; however, we would view these as short term only. In an era of higher inflation, low yielding assets (at near record prices) are very unattractive — particularly if you were to have concerns about the United States´ long term plans to service it´s own mounting deficit.

Elsewhere, slower economic growth in emerging markets has forced a retrenchment of most commodity prices. Energy related commodities have been an exception. We think that slower (as opposed to slow) economic growth and lower commodities will ultimately be good for emerging market equities and so now could be a time to revisit the asset class - though patience (as always) may be required. In the meantime, Russia seems to be in the sweet spot between high oil prices (which it benefits from) and a re-rating of emerging market equities.

Finally, it’s worth returning to the Euro crisis. Despite some alarming similarities between now and the financial crisis following Lehmans collapse there are important differences. The most significant is that policy makers, central bankers and financial institutions are working together to look through books and balance sheets to ascertain what bad debt is held where. The outcome is that we don’t see anywhere near the same level of fear and uncertainty that prevailed in 2008. This combined with the absence of excessive hedge fund leverage should see markets avoid a wholesale sell-off. Of course it’s also interesting to note the lack of shrill remarks about irresponsible lending and rampant Anglo-Saxon capitalism emanating out of Paris and Frankfurt!

1. Annualised Gross Domestic Product (GDP) latest data - June 2011.