When asked what should happen to the euro, two-fifths favoured the idea of a separate union of fiscally-strong states, while a further 15% supported a return to one country, one currency (see ‘What should happen to the euro?’ poll).
Head of concentrated alpha equity, UBS Global Asset Management
Corporate bond fund manager, Henderson Global Investors
Head of global strategy, Standard Life Investments
European equity fund manager, Schroders
Head of mid- and small-cap equity team, Baring Asset Management
In response to the poll results, Max Anderl, head of concentrated alpha equity at UBS Global Asset Management, forecast that the north/south economic divide would ultimately force some countries to exit the bloc, despite significant political impetus to preserve the euro. “Political-will can postpone it for a certain time-horizon,” he said. “While I don’t think anybody will be kicked out, I think people will want to leave. That will be the trigger.”
Chris Bullock, a corporate bond fund manager at Henderson Global Investors, and Andrew Milligan, the head of global strategy at Standard Life Investments, expanded on the theme. They argued that February’s Italian general elections, in which the ‘Five Star’ protest movement led by Beppe Grillo won substantial popular support, were a portent of things to come.
“I think the Italian election – or shall we say the first Italian election of 2013 – will be significant,” Milligan said. “One of my long-held views is that Italy is the country most likely to leave the European monetary union, because the Italian population will blame Brussels for its problems, and a politician will say: ‘Let’s go this way’.” The rise of other relatively radical political groups, such as True Finns and Greece’s Syriza, is symbolic of broader voter dissatisfaction in the bloc, he noted.
Bullock added: “On a ten-year view, it seems unlikely that there won’t be increasing pressure from electorates to leave [the eurozone]. There’s 60% youth unemployment in Greece, it’s over 50% in Spain. It’s rising in Italy and France. So it’s at the electorate level that the breaking point will come.”
Reforms will save the day
By contrast, Martin Skanberg, a European equity fund manager at Schroders, and Nick Williams, the head of mid- and small-cap equities at Baring Asset Management, were upbeat that eurozone members would implement the reforms necessary to preserve the long-term future of the union.
“Europe is making a lot of progress,” Skanberg said. “Just look at the southern European states going to current account surpluses. We’re seeing wage increases coming through in Germany, starting at 3%. They may even hit 5%. We’re seeing a gentle rebalancing all along. Meanwhile, the markets are up 35% since September ‘11, when we had the last year of crisis. And they’re up 75% since March ‘09. [Investors] love to fret. But my message and my interpretation is that Europe is doing absolutely fine – we just need to give it a little more time, and keep the bloc as it is.”
Williams added that the eurozone was making positive strides towards stability, despite being “a confederation of different states that have very different views and very different economic positions in the cycle”. Opportunities for equity investors, particularly stock pickers, have grown as a result.
He said: “The efforts that have been made are by-and-large positive for European equities. The rally we saw in the past 12 months was primarily a result of the equity risk premium collapsing, as it became apparent that southern Europe was not leaving the euro straight away.
“But there is still a lot of upside in terms of valuations, to get back to trend. And if you believe in global growth reaccelerating, which I do, then you have a lot of earnings recovery potential [in] European equities.
“So I am broadly positive on the outlook for the market. I would love to stop worrying about politics and start concentrating on companies. Within Europe, you still find pockets of world-leading capability, world-leading technology, and very well-run companies.” Recent indiscriminate sell-offs provided attractive opportunities for bottom-up investors, he added.
Disagreement over Draghi
While Williams was bullish on European smaller companies, Milligan expressed concerns over the impact of low credit availability for such firms – a problem he laid squarely at the door of European Central Bank (ECB) president Mario Draghi, who he said was doing “an appalling job” and should be asked to resign immediately – a view opposed by most delegates (see graph).
“Money supply growth in Europe is about 1.5% pa,” he said. “Senior loan officer surveys show that credit availability is weakening in many countries. This is why I am so upset with Draghi and the ECB. They have reduced the borrowing costs for government, [but] they have not reduced the borrowing costs for many companies. And that, I think, is an immense headwind for firms across Europe.”
Milligan additionally took issue with the ECB’s record on the euro, which he said had been allowed to appreciate too far against other currencies, offsetting “hard-fought” gains in productivity. He forecast that the euro would trade at about 1.15 to the dollar over the next two to three years, versus recent levels of 1.30 to 1.35. Bullock agreed with Milligan that the euro could weaken against the dollar, as a result of growing confidence that the US is closer to exiting economic stagnation.
But both Skanberg and Anderl predicted that the single currency would strengthen. “In my mind, the euro has to strengthen a lot – up until the point where the ECB thinks it’s becoming massively counter-productive,” Skanberg said. “The reason is that productivity is improving across the eurozone, and also we’ve got the currency wars. So for me, the euro is going to trend higher – partly because of strength, and partly because of its companion currencies diluting.”
Anderl noted the impotence of the ECB to combat currency appreciation, compared with countries such as Japan. He said: “Currencies are often valued on sentiment and to compare fundamentals between countries is difficult. I think the euro may actually be stronger than people expect it to be. Because I think the ECB is aware of [the euro’s strength], but it doesn’t have a mandate to do anything about it. The European countries have to come together and give that mandate to the ECB.
“So I think the euro will go [higher], because other [countries] are more effective at devaluing their currencies,” Anderl added. “It undoes the efforts of the people of southern Europe. You deflate your wages by 3% a year over three years, which is a very painful process – so, 10% lower. But then the Japanese come in, and in two months they devalue [the yen] against the euro by 35%. Whatever intentions you had to sell something to China – if it’s produced in Japan, your chances are diminished dramatically.”
In the final part of the debate, the panellists were asked to consider whether investors should be forced to accept an across-the-board haircut of 25% on their European sovereign bond holdings, given the large debt overhangs of governments in the region and the low-growth environment.
“The problem is that if you cut all public debt by 25%, you’d have an enormous problem in the banking sector – particularly in those countries where banks own a significant portion of sovereign debt,” argued Bullock.
“Again, a reason why we’ve been more positive on US banks than European banks, is that US bank loan-to-deposit ratios are much lower. Also US banks as a proportion of GDP are a multiple lower than they are in Europe. European banks in each domestic economy represent hundreds of percent of GDP. So you have an enormous problem if you do that.”
In contrast, Anderl expressed consternation at the high levels of protection often afforded to government debtholders, and said investors should shoulder the burden. “It seems to be impossible to put bondholders into losses,” Anderl said.
“I never understood why Ireland for example, put all its losses on the taxpayer. They levered up their economy tremendously, and future generations will have to suffer from it. So who decided that bondholders shouldn’t take part of the loss? If you look at Iceland, they basically showed everybody the finger and said: ‘We won’t pay, and we are going to devalue our currency’. They are doing quite well, and the currency is appreciating again.”
Anderl noted that an alternative option for European governments could be to follow the example of Japan, which is seeking to reflate its economy, despite the negative impact this would have on its – predominantly domestic – sovereign debt investor-base.
He added: “[The Japanese are] doing the honourable thing, because they own all their bonds. The old people are saying: ‘We have future generations – it cannot be us that has all the wealth’. That’s the wealth transfer that goes if you have heavy inflation. They are basically committing hara-kiri to give the country a future.”