Alot of hope was invested in the December summit of European Union leaders. Alas, it was a triumph of hope over experience. After almost 18 months of talking shop and tinkering, one might have expected the market to have developed a stronger sense of cynicism.
In the end, little of substance emerged from the meeting other than a reinvention of the stability and growth pact. The penalties will be stronger than before but it is difficult to see why countries will adhere any more to this version than the old one, although failure to do so could lead to the European Commission parachuting technocrats into the governments of a whole swathe of the eurozone, which cannot be good for democracy.
The UK Prime Minister’s veto was a useful distraction from the shortcomings of the summit. Once more, the austerity packages focus on the symptoms rather than the cause of the eurozone’s imbalances. Fortunately, the new president of the European Central Bank appears to be more attuned to the euro-zone’s woes than his predecessor. Less than two months into the job, he has already reversed the two interest rate rises enacted earlier this year. With the ECB significantly expanding its repo lending, our own economist is speculating that the ECB may be attempting back-door quantitative easing.
The hope is that if banks can access sufficiently easy funding, they will be more inclined to hold eurozone bonds. The obstacle here is that the “voluntary” haircuts imposed on Greek bonds have done much to damage confidence in eurozone sovereign debt. In imposing austerity, the European politicians make it far more likely that growth in the eurozone will be tepid at best, recessionary at worst. And growth is the one thing that could help bring down deficits and debt ratios relatively painlessly.
Factors beyond the confines of the summit walls may matter too. First, emerging markets, which had been tightening monetary policy, appear to be shifting towards easier money. Inflationary pressures in China are subsiding and the People’s Bank of China recently cut the reserve requirement ratio for banks. It may only be a matter of time before it follows through with an interest rate cut. Brazil has already been slashing interest rates in response to slower growth. At some stage, these measures should affect the real economy.
Second, the US has seen a pick-up in its economy. There has been an improvement in its labour market, manufacturing activity has been edging up and retail sales continue to defy the pessimists. If sustained, it virtually ensures the world avoids recession.
That said, it is still too early to say whether the tide has turned definitively. More likely, it will ebb and flow until there is a resolution to the eurozone crisis. With volatility likely to be our companion for the coming months, our preference is to retain a mix of asset types. US treasuries continue to offer a safe haven and, as a counterweight, we are increasingly attracted to US equities, given expectations that its economy will outperform other developed markets.
Although cautious on European equities, the relatively undemanding valuations lead us to favour portfolios with a quality growth bias such as the Henderson European growth fund. Dividends are valuable when growth is scarce and we hold several higher- yielding funds in the UK and internationally. When the destination is still unknown, it is worth packing for all eventualities.
Bill McQuaker is head of multi-manager at Henderson Global Investors