Is 2012 turning out to be a repeat of 2011? On the surface, yes it is. We have had a rally in risk assets followed by a sell-off, precipitated by the potential for yet another European crisis.
At this juncture, Spanish government bond yields have risen and there is discord on the streets of Southern Europe. Election fever is gripping France and investors are querying whether the ECB will step in and take control of the situation. But, dare I say, it is different this time, the principal reason being that through the second round of the long-term refinancing operation, the ECB has effectively decoupled sovereign risk and the possibility of a run on the banking system – this is a major positive.
Many column inches are still being dedicated to certain European data points and the recent politicisation of markets. At the time of writing, markets are also becoming jittery about comments by the ECB which suggest that they are not exiting crisis mode just yet. In our view, this is all distracting from what in years to come may be seen as clever manoeuvring by the central bank. In this context, penal bond yields are healthy for the market. Granted, that might sound counter-intuitive but European fiscal union is far off.
So, the bond markets are focusing once again on old-fashioned fundamentals, ensuring that politicians target deficit reduction programmes and growth stimuli. Markets generally are nervous about politicians’ ability (or lack of) to reduce deficits in the face of public unrest, precipitating possible capitulation, policy error and perhaps even a downgrade. And the banks are reluctant to buy this debt in fear of weakening their balance sheets even more.
Our belief is that the ECB will eventually have to step in to buy these bonds to ensure that the banks in Spain and Italy meet their liquidity requirements. Fundamental problems in Europe remain unresolved but the authorities are highly unlikely to back-track now, at least not after having done so much.
All things considered, we remain constructive on US, Asian and emerging markets’ equities but not on Europe, with the notable exception of Germany.
Germany’s Dax is a high beta market, given the level of earnings that its constituents derive from emerging markets and from China in particular. In the event of an economic recovery, therefore, Germany should outperform although the fate of the euro remains a concern. Given that the risks in Europe are pretty transparent from here, we have also taken advantage of broader European investment trusts at double-digit discounts in our higher-risk fund, including the TR European growth trust and the Jupiter European opportunities investment trust.
Furthermore, we see Ben Bernanke’s suggestion that more easing will not be forth-coming as a positive sign that the US economy continues to strengthen and neither do we see a hard landing for China. The market has taken an opportunity to take profits. Having de-risked at the start of March, we are now topping up our equity exposure.
David Coombs is head of multi-asset investment at Rathbone Unit Trust Management