IN one of life's ironies, the sustainability of the euro is being undermined most by a group of voters who say they actually want it.
Greece’s Europhile electorate could easily push itself out of the euro by voting again to reject “austerity” – even though austerity is exactly what awaits Greece even if it leaves the euro and defaults more formally on its obligations.
Inevitably, the big question is whether the global economy and stock markets could continue to “muddle through” a Greek secession or expulsion. We think they probably could, provided the European Central Bank (ECB), the International Monetary Fund (IMF) and euro area politicians are quick to circle the wagons around the euro area’s banking system.
The direct impact is manageable: official exposure to Greek debt may not add as much as 1% of GDP to aggregate euro area government indebtedness. The indirect effects are the biggest concern. If Greece goes, investors will worry that Spain (and, of course, Portugal) will be next, even though its economy and balance sheets are far less fragile than Greece’s, and an ensuing systemic euro area banking meltdown could freeze the money supply, 2008-style, gumming-up the global economy. Fears over the outlook for Europe have contributed to developed equities falling by around 10% so far, taking back most of the gains enjoyed in the first quarter. For many, this creates the risk of confusing the outlook with the recent past.
For investors who are solely concerned with finding safe havens, our advice is to be careful about the assets they choose. If seeking a safe haven, we favour cash ahead of core Government bonds and gold, even across the bulk of the euro area, because the nominal value of that cash is fixed. Cash yields may be negligible, but they can be enhanced with carefully selected short-dated defensive or secured bonds. Although we don’t envisage the euro breaking up, it’s still one of our least favourite currencies, and we think it’s likely to depreciate further (for us, the strength of the euro has been unwarranted for much of the last year).
For nervous investors who want to fine-tune their equity portfolios, defensive sectors, high-yield stocks, and US and international blue chips will likely temper market volatility. Indeed, we think that the global economy is likely to continue to grow, and that valuations don’t reflect this – nor did they before the latest setback. Looking beyond any further short-term volatility, this leaves us still favouring modestly larger than usual positions in developed stocks, with cyclical and technology sectors to the fore, alongside high-yield bonds. And we’d look to fund these overweight positions at the expense of those Government bonds, which now look very expensive, especially as we still expect to see the global economy and Europe’s banking system avoid disaster in 2012.
:: Andrew Miller is regional office head of Barclays in Newcastle.