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Multi-manager View

Europe’s rejection of austerity does not bode well for markets There are more years of pain ahead as Europe continues to deleverage and doing so in the confines of a single currency is likely to be very difficult. There is some good news, as new French president Francois Hollande and ex-president Nicolas Sarkozy were not that far apart on economic policy. They both realised France cannot continue down the path of spending.

The Greek election failed to reach a decisive conclusion, with the parties failing to form a coalition government but we should remember Greece is a very small economy in the grand scheme of things.

How, and if, Greece exits the euro is likely to have major consequences both for Greece, for which economic collapse would be guaranteed, and for European banks which will suffer considerable losses. If an exit is done in a controlled manner the damage can be limited, although Greece itself will take decades to recover. It is important to note, we are not yet at this point. Another election is likely to take place in mid-June. This will be, in effect, a referendum on the future of Greece in the eurozone and the EU.

Elsewhere in Europe, Spanish bond yields once again hit 6 per cent for 10-year bonds, as the government prepared to take a 45 per cent stake in Bankia, the thirdbiggest bank in Spain by assets. The Spanish banking system outside of the two biggest banks is extremely weak and further consolidation and capital injections are needed. The concern is whether Spain can afford to support its banking system.

German bunds and UK gilts have seen record low yields as investors have sought their “safe haven” status. Beyond Europe, we find better news. US unemployment data has resumed its downward trend and Chinese inflation data, which came in below target, suggests there is scope for monetary easing, as shown by the recent cut in bank reserve requirements.

In light of the regional situation in contrast to global economies, we remain heavily underweight in Europe, particularly given the lack of visibility on the timing and scope of any new packages aimed at securing a medium to longer-term solution to structural issues.

Crucially, fundamentals are being ignored by investors, despite them remaining reasonable, because markets are being driven by European politics. Central banks remain willing to intervene to ensure liquidity and reduce systemic risks. This support gives economies time to muddle through while banks, companies, consumers and governments reduce debt. This will take time and pain, particularly in the eurozone countries which cannot devalue their currencies to become more competitive. Economies less burdened by debt, such as in Asia and emerging markets, remain well placed to drive global growth this year.

Gary Potter is co-head of Thames River Multi-Capital


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