Not until each and every Eurozone government currently struggling to handle oversized budget deficits and sovereign debt has proved beyond doubt that they not only have the necessary will and political resource to produce a sustainable and workable solutions and begun the job will market fear go away. So why then are markets somewhat calmer today….could it suggest perhaps that the sovereign debt fears that has been so evident in markets since the Greek situation caught EU political authorities on the hop may have been overdone? Hardly – far more likely is that serious investors will prefer to believe that unless we are talking serious potential asset destruction market bashing of equity valuations has limits. They might also view that whilst the Euro is clearly still headed down creating unnecessary panic on the back of a handful of busted Spanish savings banks belatedly merging would most likely have far more devastating consequences that any of us would dare imagine. Nevertheless, be in little doubt that the Euro will remain the bad kid on the bloc and that as a consequence the dollar will on the up.
No matter what your individual view may be about where markets go from here or whether or not you might believe that amounts of carried risk should be reduced or that events of past 48 hours in markets had been overdone we are dealing with yet another set of unknowns. Central to these is the unprecedented level of concern now emanating from the US on the whole European sovereign debt issue. To a point we may regard specific US concern as merely paying selfish regard to the protecting its own heavy investment commitments in Europe of course. Put more simply that means if the Euro falls and the dollar rises then profits available from US investment in Europe – be it banks or whatever will fall. A cynic might prefer to point out that coming from a country that is itself propped up by the willingness of China and Japan to continually fund its debt requirement is quite rich! Not that any of us are perfect of course but I do find the attempt to write off Europe and particularly Eurozone and its currency may yet backfire on the US. Add Korea into the mix, rumour after countless rumour over what the next moves of the ECB and EU authorities might do next plus the complete disbelief that the EU political authorities have much more than a clue means that we really do have a perfect recipe for fear. Almost of necessity fear translates into the natural insight that we could be moving closer toward the second stage of a global financial crisis. I want to say what absolute nonsense here but I will for the moment refrain. But it does beg the question that while concern on government deficit levels must be right why is it that Spain which has debt that represents about 60% of GDP gets clobbered whilst Japan which has debt to the tune of 195% of GDP (second only to Zimbabwe) does not? I am afraid I do now have a particularly sensible answer for that. Greece by the way has debt representing about 108% of GDP, France and Germany are around 78% of GDP with the UK not very far behind.
Even so, in terms of the so-called advanced economies we know that most of them, or should I say of their respective governments, are technically bust. That does not mean that they are short of wealth be it in assets form or anything else or that many are neither robust nor even in some cases still enjoying growth. We have of course lived beyond our means for far too long and since the mass of cheap liquidity that funded the show dried up the chickens came home to roost. Adjustment to new realities is the order of things today. And we are all adjusting too; some countries such as Ireland, Portugal, and the UK are adjusting very quickly. Whilst Ireland led the way and Britain, aided by the election result that led to a coalition government being formed, is certainly headed on the same right track in my view. So too is the US albeit that unlike Ireland and the UK the worlds largest economy is almost alone believing, as it has always done in the past, that achieving the same ends by returning the economy to sustainable growth will be the best way out.
When it comes to how markets sort out a specific problem I am as most of you know an optimist. Markets always over react of course but they then quickly readjust. Thus we see markets today responding positively in the traditional manner. Will it last? I doubt it. Meanwhile regular readers of my daily blog stretching back over the past nine years will have heard me say many times that you ignore markets at your peril. The message then is to listen and follow. In doing so it is true that for several weeks I myself have been concerned that Libor had been edging up and that this was probably telling us that something potentially even worse than we had seen for a while was coming. True, over the past few months equities had appeared to be running away with themselves and yet here we are in late May all but back to where they had been last October. But watching the various separate events unfold this past twenty four hours did not provide me with the thought that we are about to hit the end of the world although it was troubling nonetheless.
Meanwhile subtle changes going on now suggest that liquidity will continue to tighten over the next few months meaning that the outlook for the rest of 2010 will be further clouded. If right that will negatively impact on corporate performance which in turn will impact on individual national economic performance. What is fairly certain is that volatility will rule the day in equity, bond, currency and commodity markets for many months ahead. Dark clouds ahead then but for all that I do share the view of my chum Anthony Peters at Swissinvest when he said today that we need to stand back a little and that too much prepositioning for a crisis could well bring it on by itself.
Some Final Thoughts on Sterling
As the Euro got further tanked yesterday I received several requests for a view on sterling. My answer was the same throughout – don’t go short young man! Why? Principally because I believe that as the coalition government in the UK has rightly decided not to go for growth as a chosen economic route and that with great speed it has already begun the long process attempting to balance the UK books sterling will I my view be perceived as a relatively safe haven currency over the coming year? Perceptibly the UK government through what it has already announced in the form of emergency cuts and what it will likely say and do on the June 22 budget has probably done enough to ensure that the triple A 'rating is left in place. There are other reasons too. Firstly while none of us will likely argue that at £156bn close to 13% of GDP the UK has a larger government deficit than Greece there can be absolutely no comparison between the two nations. Indeed, neither can there be any comparison between the UK and other troubled Eurozone nations such as Spain, Portugal or even Italy.
I would argue that in the eyes of the rest of the world the UK has already proved itself to have the right self disciplined approach to sort its problems. Moreover remember too that the UK has, at 12.8 years, the longest debt maturity of any advanced economy. Compare this with Spain at 6.7 years or the US at just 4.4 years. Next, while individual Euro based economies lack any independent monetary policy and ability to devalue the Euro currency [assuming we ignore how Greece managed single handedly to wipe 30% off the value of the currency] the UK does still have power over its currency. Sterling has of course been heavily devalued over the past eighteen months and whilst it is true that this produces benefits such as raising export potential and of necessity reducing the value of carried debt the downside is inflation – something that is higher in the UK than most Eurozone member states.
