Global spotlight
Global spotlight is a short topical article on different themes in the financial markets written each month by senior fund managers, analysts and members of the strategy team at Standard Life Investments.
The most recent articles have covered:
- 10 May 2012 Sell in May?
- 04 May 2012 Growth compact
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Look underneath the bonnet
16 May 2012
Commentators are vying to create the most frightening metaphor for the future of Europe: standing on a precipice, walking through a mine field, facing Armageddon. European share prices are down about 15% from their recent peaks, approaching the 20% trigger for a bear market, while bond yields in Spain and Italy are near levels which previously have triggered a response from the ECB. What should investors look at to decide whether to buy or sell?
The job of being an investor has certainly become more difficult in recent years. On top of being an economist – when might the European recession end? – and a central bank watcher – what might the ECB do next? – and a strategist – which markets are cheap or dear? – it is essential to be a political analyst. Of course, markets are volatile when they are trying to price in the outcomes of the election in Greece, the parliamentary elections in France and the Irish referendum, against the backdrop of a series of European summits. Political bargaining, opinion polls and votes will be the currency to analyse – often on a daily basis.
It is impossible to forecast the outcome of so many events. For some time Europe has faced a three pronged choice: muddle through, crisis or collapse. Collapse refers to the break up of EMU as we know it, matching the risk aversion last seen in 2008. Crisis refers to some form of Greek exit from EMU, possibly disorderly and possibly relatively contained by massive central bank support. The most likely scenario remains the first one – buying time and muddling through, which has been the case since the Euro-zone crisis erupted two years ago. Certain conditions are already falling into place: more politicians calling for a ‘growth compact’ to kick-start activity alongside less onerous fiscal austerity plans.
The pressure on governments to buy more time is considerable – not only because the risks of a major collapse are abundantly clear but also because underneath the doom and gloom, two positive trends are appearing – small flames which need to fanned into life. The first is that the conditions are falling into place for growth in Germany, the engine room of EMU. The second is that the improvement in competitiveness in the rest of Europe has gone further than many realise.
Amid the news that much of Europe is in a modest recession, Germany stands out. Its economy grew 0.5% in the first quarter, led by exports reaching an all-time high, helping industrial production return towards levels seen just before the 2008 crash. Looking ahead, the next important step would be domestic demand kicking in. Early signs are positive. As unemployment reaches its lowest levels in over 20 years, so wage demands are growing. Strikes have been seen in the engineering sector calling for a 6.5% wage increase. Interestingly, the Bundesbank recently signalled it would accept higher inflation in Germany than in other parts of the Euro-zone as part of the rebalancing process. Additionally, the property sector is starting to benefit from the ECB's easy policy and record low bond yields. Construction orders have jumped to their highest level since early 2008.
A key factor causing the Euro-zone crisis has been the growing uncompetitiveness of many EMU economies versus Germany and the rest of the world. The good news is that improvements are being seen, some forced on economies by government austerity packages, say in Ireland or Greece, some voluntarily adopted, say by workers agreeing to wage restraint and productivity improvements in companies across Europe. The net result is that relative unit labour costs have fallen in Ireland by close to 30% from their 2005 peak, and are 10% or so better in France and Spain. The changes are resulting in much smaller current account deficits in countries such as Spain and Italy, needing less capital from overseas. The adjustment process will last many more years but a start has been made.
The House View remains Light in European assets until it is much more certain that a viable policy response will be seen. European policymakers face vital decisions at their summits in May and June. Compromise on all sides can buy time for the necessary economic adjustment needed across Europe to develop even further. Failing to do so would lead to even more disorderly markets than those seen in recent days.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
