The latest European Union summit has seen politicians promising direct funding for Spanish banks and the softening of conditions surrounding bailouts for stricken sovereigns, with some experts seeing it as the start of a more integrated euro area.
We believe, however, that what has been delivered so far has been a stunningly conventional and wholly unimaginative ‘eurofudge’, as politicians hijack concessions for their own ends, while deferring the details of implementation further down the line.
The coming year sees the continuation of what has been a very busy political calendar, and the question we are asking ourselves is, in Europe’s case, whether anyone will challenge the current order and propose a radical solution to the sovereign crisis.
We are speaking of potential game changers and the larger-than-life personalities who possessed the revolutionary thinking to propel their countries out of deep crises. In living memory, the profound failure to contain severe inflation in the late 1970s saw Thatcher’s Government deliver its monetarist shock treatment in the early 1980s. While painful in the short run, it paved the way for a near doubling of the FTSE.
Further back in time, FD Roosevelt’s response to the Great Depression, in the shape of an extensive series of programmes under the New Deal, came in extreme contrast to the balanced-budget thinking that had preceded it.
While bemoaning a lack of creativity in the EU’s response to the euro crisis, there are some signs of original thinking, although not perhaps of the sort we would like to see.
One of our most interesting observations is in Italian politics. Former leader Silvio Berlusconi could well stand as a candidate in Italy’s 2013 election, and his rhetoric is starker than most. He has spoken openly about the crisis that Italy faces as having three simple outcomes: either Germany bails out Italy; Germany leaves the euro; or Italy itself forges an exit.
We are not scaremongering, rather we wish to encourage investors to open their minds to the possibilities, rather than expecting endless sticking plasters from the EU and its funding mechanisms.
If not Italy, a challenge to the assumed order of Europe could come from other peripheral members. For example, Sinn Fein’s campaign stance in 2011 was that an EU fiscal pact would see the end of economic sovereignty in Ireland.
There may be an element of truth in this. If Germany is moving towards a federal Europe, and with it the common issuance of debt, then one assumes that, quid pro quo, Germany will demand that certain powers pass to the centre.
So what should investors do given these political risks to the markets?
One option would be to own equities and ride the rollercoaster, given evidence that lower starting valuations tend to produce the best 10-year annual returns.
But we understand that not everyone would be able to sleep comfortably doing so.
As an alternative, one strategy that we have developed over the past few years in our multi-manager funds is to react to near-term volatility by building more risk into a portfolio when sentiment is positive, and introducing some safety nets when the mood seems to be turning more sour.
We advocate that a judicious selection of quality risk assets be coupled with some natural hedges. For us, these currently have a US flavour. Against exposure to US equities, which is one of our favoured quality regions, some exposure to US Treasuries acts as a hedge against market weakness, while gold offers some protection if the US deems it necessary to reintroduce large-scale quantitative easing.
We recognise it is not within our powers as fund managers to gaze into crystal balls but we can actively monitor the political developments, evaluate the possibilities and adapt our strategies in the event of numerous outcomes, blending flexibility with caution. This is how we believe we are stepping up to the challenges in the hour of investors’ needs.
Bill McQuaker is head of multi-manager at Henderson Global Investors