An interesting divergence has transpired between what economists are predicting, and how one might expect markets to react – albeit in ‘normal’ circumstances.
Perhaps instead of doing ‘whatever it takes’ to simply save the euro, the ECB should apply the same resolve to saving the eurozone economy
The Bank for International Settlements, for example, has made the salient observation that markets appear to be gathering a head of steam during the very period when major forecasters, such as the IMF, are turning bearish on the outlook.
The World Economic Forum Global Risks 2013 report says that “systemic financial failure cannot be completely discarded’’.
At face value this hardly appears a positive environment within which to invest. Despite this, consensus appears to have concluded that the worst is behind us. This is particularly the case if one frames the assessment in terms of eurozone break-up risk. In support of that argument one can point to the effectiveness of ECB initiatives, in particular the Outright Monetary Transaction (OMT) programme, in driving down eurozone peripheral yields. One would naturally equate a lower yield regime with a lower risk environment.
However, it is still surely the case that the central macro theme remains unanswered – the question of whether the eurozone crisis has passed its nadir or whether (much) worse is yet to come.
This all depends on whether one views recent developments as having solved the crisis (or least put in the necessary ingredients for the solution), or whether they have merely secured a stay of execution.
This is a fundamental question for investors, most especially those in the eurozone.
The recently published Employment and Social Developments in Europe 2012 (authored by Laszio Andor, Commissioner for Employment, Social Affairs and Inclusion) begins with the remarkably candid sentence: ‘‘2012 has been another very bad year for Europe.”
Indeed it was. Quite why 2013 should be any better is not immediately clear – it is dangerous to casually assume that things can only get better. More of the same, in terms of policy, will surely lead to more of the same, in terms of economic result.
The report adds: “Very importantly, the social and employment trends are diverging significantly in different parts of the EU. A new divide is emerging between countries that seem trapped in a downward spiral of falling output, massively rising unemployment and eroding disposable incomes and those that have at least so far shown some resilience.’’
A major constraint on the eurozone is the seeming inability of its leaders to distinguish between political idealism and economic pragmatism. Investors are only interested in the former to the extent that it influences the latter. The opposite applies for politicians, especially those with grand social objectives. This difference in perspective manifests itself most clearly in respect of the euro itself. Politically, the euro is the most powerful symbol of European unity. Equally, one can build a plausible economic argument that the euro is the cause of the problems, not the catalyst for the solution.
For example, in the pre-euro era, hard currencies such as the Mark tended to appreciate in line with increasing economic output. The appreciation served to dampen the extent of the surplus generated. The flipside was that a depreciating currency would help deficit countries. This automatic stabiliser was removed once the common currency would be adopted. The resulting growing imbalances were predictable enough. So is their perpetuation under the current regime.
There appear to be no circumstances in which politicians will consider that the single currency might be a failure and is possibly leading to an unnecessarily bleak outlook for the southern periphery – no amount of negative growth, no decline in aggregate demand and no level of unemployment.
The primacy of political ideology over economic pragmatism is a major concern for equity investors in the eurozone. If an economic bloc is prepared to accept wide divergences between its member states (now well documented), and for the bloc as a whole to trail other major economic blocs (note how eurozone unemployment reached a record high last October as the US continued lowering unemployment), equity investors will deploy their capital accordingly. This leads us to a strategy to avoid equities which are exposed to eurozone domestic demand – more accurately, the domestic demand of deficit countries within the eurozone.
We note that many countries would like to have a depreciating currency in order to re-inflate the economy – but not all of them can have it. Ironically, the economic area that needs it the most is the one least likely to get it – the eurozone. This is due to a hawkish Central Bank intent on maintaining its focus on the primary objective of price stability – good for Germany, less so for others in the current circumstances. Perhaps instead of doing ‘whatever it takes’ to simply save the euro, the ECB should apply the same resolve to the more fundamental problem of saving the eurozone economy.
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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
Martin Webster is head of equity research at Curmi and Partners Ltd.