MAY 2010                                                                                                                                         Download PDF Version

Why Bother with Europe?

i was having breakfast yesterday with a global-macro manager friend of mine ,whose opinions I rate very highly, discussing Greece’s plight. Her conclusion was “Why do we bother investing in Europe?”.

Traditionally the European equity markets were seen as a higher beta allocation, this is no longer the case. If you want beta we can now easily invest in Asia or in the BRIC economies. If you want a deeper market with defensive characteristics you can get this in the USA.

European fund-managers have generally been stock-pickers rather than concerning themselves with the macro-picture; now the macro dominates Europe and looks set to continue to dominate for the next 12-18 months.

Spreading contagion
It is possible that the contagion will spread rapidly to the other indebted nations; Spain was downgraded late last night and the secretary general of the OECD has helpfully likened the crisis to the ebola virus. However, with inflation still low and interest rates looking likely to stay low there remains good support to bond prices. All this will change as inflation re-emerges and interest rates start to increase. Then will anyone want to bother with European debt, be it Greek, UK or German? The problems may come not in 2010 but in 2011.

This again reinforces one of our key themes, namely that high quality corporates will trade through their respective government debt and certainly represent a less risky investment. The current era has been one of the best times to be a global corporate. You have been able to move your manufacturing to areas of cheapest labour and move your headquarters to the areas of least tax. Bearing this in mind it is not surprising that Western governments are in a bad way while Western corporates with global reach are in fine health.

We believe that the pendulum has probably swung too far in favour of the corporates. Unemployment figures are looking bad, and, in particular, the average length of time someone stays unemployed is increasing. Therefore we may be entering a more protectionist phase where governments really do try to keep more of the manufacturing jobs on home turf. This theme will play out over a longer time-scale and we would therefore remain buyers of corporate over sovereign debt in the short and medium term.

A longer theme
I have not answered the question posed at the start of this, and possibly it was more rhetorical anyway. However, it does highlight a number of important asset allocation decisions that clients will need to make both now and for the longer term health of their portfolios.


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