Not long ago, Europe was regarded as well placed to lead the global recovery. Now, it’s a no-go zone. That spells opportunity, and not just for the bravest contrarians, says John Stepek.
Greece has been saved. The European Union (EU) and the International Monetary Fund (IMF) stepped in last weekend and agreed to bail out the stricken country. If Greece can’t find the money elsewhere, then the EU and the IMF will stump up €45bn between them to tide the country over (for more, see: The EU’s short-term fix for Greece).
In reaction, the Greek government’s long-term cost of borrowing fell, and the country even managed to slip out a little bond issue on Monday, which was over-subscribed. So all’s well that ends well, eh?
Not quite. Not at all, in fact. The bond issue in question may have been oversubscribed, but the amount raised came in at just €1.56bn. More importantly, the duration of the bonds was just six months and one year. Even over this short period, investors demanded far higher interest rates than just a few months ago. The yield on the 52-week debt, for example, came in at 4.85%, from 2.2% in January.
So markets are hardly convinced. And that’s no surprise. Greece still needs to raise another €11bn by the end of May. With the EU-IMF package on the table, the short-term problem of liquidity may have been addressed. Greece will be able to get money from somewhere, even if it means calling on the emergency funds.
• How to play Europe with minimal risk
• Four of Europe’s most solid stocks
But in the longer run, Greece still needs to pay off its debts, not just roll them over. That means painful economic restructuring and deflation. And not just for the Greeks. As Neil Unmack says on Breakingviews, Greek “citizens will probably want to see bondholders share some of the pain through a debt rescheduling or extension, if not an actual write-down”.
Perhaps more importantly, Greece isn’t the only eurozone country worrying the markets. Portugal is among the next obvious candidates for the ‘bond vigilantes’ to pick on. One of the most important factors in determining whether a country will run into trouble, say Tim and James Lee of Pi Economics, is its national savings rate (including companies and the government, as well as individuals). “While a large budget deficit is not a good thing, it will only lead to a debt crisis if it cannot be financed.”
This financing “ultimately must come from private savings. These can be domestic savings or foreign savings. Countries such as Greece, Portugal and the US, with extremely low domestic savings rates, have so far been surviving on overseas savings”. But come the next shock for the markets, says Pi Economics, foreigners will pull their capital back home. “At this point, deficits must be financed from domestic savings only.” But many countries “will not have high enough savings to do so… an economy with a savings rate that is structurally too low to support a structurally too-high deficit, such as Greece, is inevitably headed for disaster – no matter what bailouts or other measures are attempted”. Among the most vulnerable European countries on this measure, says Pi, are Portugal and the UK.
And, adds Dylan Grice of Société Générale, at least “Greece is a small enough country to be bailed out by Europe. If we add in Portugal, Ireland, Italy and Spain… the risk could be systemic”, due to the hefty exposure of banks across Europe to debt in all these countries.
So it’s perhaps little wonder that Europe (and the eurozone in particular) is now a pariah in the eyes of global fund managers. The latest monthly Bank of America Merrill Lynch global fund manager survey found that a net 18% of global fund managers are underweight European shares. That might not sound like such a big deal, but this is at a time when fund managers in general are rampantly bullish. Managers are holding hardly any cash, and are even starting to get excited about Japanese equities, which shows just how bullish they must be feeling.
Indeed, “as recently as five months ago investors regarded Europe as the most attractive play on global economic recovery”, says Patrick Schowitz of Bank of America Merrill Lynch. Yet with the fear over the potential breakdown in the region, “Europe has become a no-go zone”.
What can investors do?
Of course, when most fund managers are describing somewhere as a “no-go zone”, that’s when contrarians prick up their ears. If a region is that widely disliked by the herd, then there must be some opportunities there.
But that’s not to say we’d suggest piling into Greek banks. Saxo Bank recently put out an interesting note on Greek stocks to watch, including lottery operator Opap. The trouble is, while some of these stocks do look interesting, if the crisis erupts again – as it almost certainly will – they’re likely to get cheaper. Better to be aware of them for now and keep them on your watch list for when better opportunities arise to buy them.
• As Julian Pendock of Senhouse Capital points out (see: Four of Europe’s most solid stocks) , there are plenty of other solid companies giving global exposure but trading at a discount to their peers due to being listed in Europe. He gives four of his favourite tips in the region.
• And my colleague Theo Casey looks at ways to play the more promising parts of Europe, as well as how to shield yourself from another fall in the broader markets. See: How to play Europe with minimal risk
• This article was originally published in MoneyWeek magazine issue number 482 on 16 April 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don’t miss a thing, and get instant access to all our premium content,
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