The Fundamentals of Panic
The whims of investor sentiment often hold sway over the markets, even if fundamentals might seem to dictate otherwise. A “herd” mentality can take over and certain asset classes or regions fall out of favor, whether rightly or wrongly so. In the first half of this year, the investing herd was stampeding out of Europe, with its crushing debt crisis and specter of a euro breakup. Today it appears sentiment is shifting direction—toward the euro’s survival—so will the herd make a U-turn? John Beck, London-based SVP and co-director of Franklin Templeton’s International Bond Group, is cautiously optimistic, but he’s also a realist about the time it will take for Europe to recover.
Investors have grown impatient waiting for the eurozone economies to recover, but Beck reminds us that patience is a virtue. He says it is impossible to go around the time required for the recovery process, but he is already seeing improvement in three key areas: the banking system, sovereign debt, and politics.
“We are beginning to see things put in place that we feel will at least begin to stabilize the situation, to get it resolved over a period of time that is achievable. In December of last year we had one step toward resolving the problems in the banking system—the three-year Long-Term Refinancing Operations (LTRO).
More recently we’ve had some of the sovereign problems partly resolved with the ECB’s announcement of Outright Monetary Transactions (OMT). It requires contingencies for countries that apply for the program, so that means there is political agreement from the stronger countries to provide financing for the countries that are struggling at current terms to raise money.
The third element was the political commitment. Dutch elections resulted in a pro-European outcome, and it’s been voted through in the German parliament.
So we have a combination of improvement in the banking sector, in the sovereign sector and in the political sector. We do finally have an opportunity to begin to resolve things, so one could take a more optimistic view.”
Time to Return to Europe?
The euro was conceived of as a single zone, but the debt crisis has proven the risk clearly is not equal among the member countries. In Beck’s opinion, some areas remain a bit sickly, but others are on the path to recovery.
“For some countries, we would still be very cautious. We think there are significant reservations over Greece, and probably over Portugal, and a question mark whether the OMT is perhaps beginning to resolve some of the problems in Spain. But for other countries where the debt-to-GDP ratio has been more stable, where the fiscal position has been less in deficit, for example, in Ireland or in Italy, there are all grounds for optimism. We think some of the peripheral economies now do offer some value. We have not had exposure for some time to some of the weaker economies, but we did begin to build exposures to Italy in the beginning of this year. And we continue to be encouraged by some of the signs that we see both in Italy and also the support mechanisms that the European institutions have put in place.”
Beck is more optimistic than he has been in recent months, but he’s also a realist when it comes to Europe. As they say, Rome wasn’t built in a day.
“Banks have got funding for three years, but what banks are likely to do in those three years is lend less money. That’s not going to be good for European growth. Governments now can get money through the OMT, and again that’s good for governments, but what will governments do? We think they are likely to spend less money over the next three years to bring the fiscal position in order, and again that’s likely going to be a drag on growth. The private sector was perhaps a little spooked by some of the political uncertainties and not terribly willing to spend money either. So we think growth in Europe is going to look pretty weak for some time.”
Everybody Just Calm Down
So if Beck doesn’t expect anyone to ramp up spending anytime soon, what might he think does have the power to restore investor confidence? A period of calm might be a good starting point.
“In the last two to three years we have stumbled from one crisis to the next crisis and hoped for resolution that was never really ultimate and forthcoming. So we hope for a quiet period where we don’t have to look forward to an election, or vote, or disaster, or the necessity of a midnight finance ministers’ meeting. We hope we can actually go back to some perhaps slightly more normal degree of relative spreads between sovereigns that reflects their credit fundamentals rather than the fundamentals of panic and liquidity.”
What do you think? Is it time to invest in Europe again, and if so, where? Please leave us a comment with the way you see it.
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What are the Risks?
All investments involve risks, including the possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability, and political developments. Investments in developing markets involve heightened risks related to these same factors. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial instability of some countries in the EU, including Greece, Italy and Spain, together with the risk of that impacting other more stable countries may increase the economic risk of investing in companies in Europe.