12th June 2012

Investment Commentary from Creechurch Private Wealth

Greek politics may determine the short term machinations of the Euro, however, it is Spain that poses the single currency’s most challenging problem. The Eurozone’s fourth largest economy is caught in an increasingly desperate spiral of deepening recession, ailing banks and unsustainable borrowing levels. We expect this uncertainty related to the European political process, and especially Greece and Spain, to continue to create ongoing questions for investors, however, over the long-term, this peak of risk aversion undoubtedly offers opportunities.

Broadly speaking, financial markets continue to experience headwinds primarily in the form of Euro sovereign debt woes as mentioned above coupled with fears surrounding weak banking systems and anemic global growth. In terms of Europe, the time for significant decisions is approaching rapidly and if we are to gauge from recent market reactions, many are fearful that the policy response will fall short. All eyes have moved to the 17^th June when the Greeks will have another stab at electing a functioning government.

Many feel that we have moved into the ‘Intervention Zone’ where all paths lead to the next major round of action from the authorities. Ironically the longer the European Central Bank continues to occupy the moral high ground, the more they eventually may have to intervene. Safe haven asset flows have resulted in strong performance from US sovereign debt with the 10-year benchmark bond yield reaching record levels and fresh lows in the equivalent German Bund − showing the market shifting firmly to capital preservation mode. 

Whilst the European Central Banks LTRO’s (Long Term Repurchase Operations) may have bought time and provided the catalyst for the risk rally witnessed in Q1, these liquidity operations have not acted as a circuit breaker, unlike the quantitative easing employed by some of their major counterparts across the globe. Regardless the economic areas two key underlying deficiencies remain stubbornly in situ, namely (i) large economic imbalances; and (ii) the lack of fiscal integration. Overcoming these key issues, assuming that is possible in the first instance, will undoubtedly take years! 

We believe that the probability of the ‘Grexit’ (Greek exit from the single currency) to be modest; Europe appears to be switching away from pure austerity toward more growth friendly policies in the short term, symbolised by Francois Hollande’s victory in the French presidential elections and local elections in Germany.

With so much having been written on the ‘European issue’ of late with numerous scenarios thrown into the mix perhaps the most likely outcome is that we stagger on for the next couple of years, with governments failing to move toward fiscal integration but the euro area staggers on (with a lot of help from the ECB!) as economic reforms and fiscal belt tightening ultimately pay off and the bloc’s economy rebalances, albeit gradually. Either way the missing link that would remove credit risk from Euro area Government bonds, a central bank that stands ready to act as a true lender of last resort, seems a long way off. No doubt financial markets will continue to challenge sovereigns in the absence of this end game solution and staying the course will likely require a lot of heavy lifting from governments.

And finally…

As always, we will continue to be faced with 24-hour news and the media beckoning chaos in one form or another; the result of which can leave it very difficult for the individual to look through these periods of uncertainty toward the long-term picture with long-term investment horizons. It requires a degree of emotional detachment that proves elusive for many, let us not forget those wise words from the sage of Omaha− ‘be fearful when others are greedy and greedy when others are fearful’.