Eurozone sovereign debt crisis requires isolation of Spain and Italy
Paul Brain, head of fixed income at Newton, said that solving the eurozone crisis through a restructuring of sovereign debt is only possible in the current framework of politics and financial authorities if a way can be found to isolate Spain and Italy from the so-called three little PIGs.
The fears of investors are currently focused on the four horsemen of the bond apocalypse Brain said: inflation, defaults, monetary tightening and price manipulation.
Each of these could be tamed through the existing European stability mechanism and facility already committed to bailing out the three PIGs – Portugal, Ireland and Greece – as well as developments in the market itself. For example, an element of debt forgiveness could see off the default horseman, while slower inflation could see off the fear of inflation, and monetary tightening.
A way of repackaging the debt of countries such as Greece could see off the problem of ever widening spreads compared against German bunds. Referring to the work of so-called “bond alchemists” who had restructured the debts caused by recycling petrodollars of the 1970s into corrupt economies of South America – fixed through the Brady Bond plan – Brain said a similar excercise could only occur once the market excluded Spain and Italy from the mix.
One issue he is not concerned over currently is defaults tipping over from one jurisdiction into another. For example, there is no mechanism currently in place that would cause a default on Greek debt to tip over into causing German debt to legally also be in default. This means government debt is in a different position from corporate debt, where a default on debt owed to one creditor would affect all debt.
That said, he added it was not enough for European politicians and monetary authorities to continue to “kick the can down the road into 2012.” Drastic action is required of Europe’s politicians and authorities.
Private sector joy
The difficulties facing sovereign debt are meanwhile failing to be replicated in either the area of corporate debt markets or large cap equities.
For example, Brain says that Newton had no French sovereign debt exposure, but liked French corporate bonds – partly because French governments backed its corporate sector. It is politically very hard to countenance the idea of unemployment caused by failed corporations there, he said.
Raj Shant, head of European Equities at Newton added that the eurozone crisis had created exceptional circumstances for German exporters and other high value add companies that lead their field. Newton points to ASML, which supplies semiconductor manufacturers, as an example of a company that has had no problem selling its bonds and holding on to its equity investors. French cosmetics firm L’Oréal is another; it does 60% of sales ex-Europe, and if shares fell because of broader fallout from concerns over Italian or other bonds it would merit buying, Shant suggests.
Shant is also keen to stress that the overall European project still retains considerable support across the Continent – something that is not necessarily as apparent in London and New York. With forecasts for inflation to peak in both Europe and key emerging markets peaking, the outlook for economic growth globally is improving, and this is likely to drive opportunities for well placed European companies in their respective market sectors.
Fred Moore, investment manger on the Newton European Higher Income fund said that Europe ex-UK was set to grow dividends faster than any other region through 2010.