It has become impossible to look at the prospects for stockmarkets now without considering some kind of resolution to the euro crisis. There are problems across the pond as well but at least the Americans have a currency they are able to readily devalue. European politicians seem content to kick the can further down the road and, in the absence of firm action, investors remain nervous about equities and European equities in particular, which have fallen heavily.
Political commentators seem to think the sticking plaster policies will continue. The trouble is that markets are in an impatient mood and I think we are getting close to the point where they force politicians’ hands.
The increase in Spanish and Italian bond yields seems to be driving the crisis at a faster pace. With 10-year bond yields at around 5.5 per cent, an increase of 1 per cent or so might just push the whole thing over the edge. It seems eerily reminiscent of September 1992, when the UK was ejected from the European exchange rate mechanism.
We still have Greek politicians denying there are any big problems and rushing to push through asset sales to pay back an amount of debt that appears to be unpayable. For Greece, what we need to see is debt forgiveness, probably for at least half the debt. This would solve Greece’s problems, at least in the short term, but it would not necessarily be a resolution to the crisis. Banks would crystallise heavy losses on their bond holdings and the spotlight would turn to other indebted countries.
The crux of the problem for the markets is that investors can see no clear way through this crisis and it is even difficult to see what options remain. Will the Germans ultimately leave and go their own way? Will the Greeks leave and return to the Drachma? And where is the line in the sand drawn? Does the entire southern European bloc end up leaving?
None of these is a palatable option. They will all be hugely disruptive and expensive. Unfortunately, the more you look at the numbers, the more impossible it all looks, not just in Greece but elsewhere. According to Chris Rice, a fund manager at Cazenove, Italy needs to refinance £300bn of debt a year for the next few years. As he said in a recent newsletter, “With nominal GDP barely growing, it is a non-starter as a policy.”
Given the impossibility of the situation, an answer for the Germans might be to just let Southern Europe go. Germany has so far been a big winner from the single currency. As one of the world’s major exporters, the currency level it is enjoying is prob-ably 40 or 50 per cent lower than if it still had the Deutschmark. It has made German companies exceptionally competitive. You only have to look at the Swiss franc to see what might happen if the Germans decided to go it alone.
That would the impact be? A German recession but quite possibly a big buying opportunity for European equities outside of Germany.
What do investors do? Remember, with the ERM ejection in 1992, the markets fell precipitously initially but then rebounded strongly. In fact, the whole episode turned out to be a golden buying opportunity for UK equities. My own feeling is still that you should make sure you have a reasonable amount of cash in your portfolio to give you the option to buy more equities and corporate bonds if markets fall. If there really is a big fall, I think it will herald a huge buying opportunity.
I suspect the markets will at some stage completely lose patience with the European crisis. Muddled promises of austerity measures and fiscal integration will no longer cut the mustard and things will come to a head. I may be wrong and the whole thing could stagger on for another year but the volatility we are seeing in the market suggests otherwise.
Mark Dampier is head of research at Hargreaves Lansdown