The euro crisis and global markets
Intense stock market volatility persists as the outlook for the global economy remains uncertain.
At the top of the list of concerns is the eurozone crisis, but debt worries in the US and much of the developed world continue to hinder economic growth. With the IMF slashing its forecast for global growth this year, investors are increasingly concerned that the world is heading back into recession.
Against this challenging backdrop two of our most senior fund managers, Nick Gartside (manager of the JPM Strategic Bond Fund) and Talib Sheikh (manager of the JPM Cautious Total Return Fund) share their thoughts with investors.
What has caused the turmoil?
Nick Gartside: A collapse in global growth expectations has heightened concerns over the solvency of many highly indebted economies, particularly in the eurozone. If countries are earning less income as a result of slower economic growth, they will find it harder to pay their debts. The larger the debt, the more difficult it becomes to make interest payments, which helps explain why the eurozone crisis has intensified recently with many peripheral countries now in deep recession.
Talib Sheikh: On the positive front, at least there is now an admission from European officials that there is a problem. Until recently many eurozone policymakers wouldn’t admit that there was an issue. They are now looking at taking steps towards a more comprehensive solution, although the way ahead could be difficult, not least because of the time it takes for the eurozone’s 17 member states to agree and implement any new policy action. Things could therefore get worse before they get better.
Are we facing another global banking crisis?
TS: The eurozone debt crisis is spreading to the region’s banking system. Many banks have large holdings of peripheral eurozone government bonds, but may lack the capital required to withstand a significant writedown in their value – an eventuality that is looking increasingly likely as Greece moves towards default. The trouble is that it is difficult to tell which banks are most at risk, which has dented confidence in the banking system and resulted in a collapse in banks’ share prices. The problems at Dexia, the Franco-Belgian lender rescued by the French and Belgian governments in early October only serves to highlight the severity of the crisis.
Therefore, while we think many banks are looking attractively valued following the collapse in their share prices, we are not buying European banking stocks at the moment – we just don’t know how much holders of Greek bonds could lose, or which banks have factored in appropriate losses.
Where are markets headed from here?
NG: For the long-term outlook Japan perhaps provides a worrying roadmap for the west in terms of what can happen if you don’t control your debts. As Japan’s debt levels have continued to spiral, economic growth rates have been lower and government bond yields have plummeted.
TS: In the short term, we are worried about how the crisis now seems to be spreading across stock markets. Initially, the problems were very much focused on Europe, however, we have recently seen precipitous falls in emerging stock markets. This selloff suggests emerging market growth may be weakening, which may signal further stock market volatility as investors had hoped that growth in emerging markets would support the global economy.
One thing that could lift markets in the short term is strong action from Europe, although the crisis may need to intensify before any action is taken. Given the slow pace of political progress in the eurozone, we believe the European Central Bank (ECB) will need to step in and provide massive support for indebted economies if markets are to stabilise – something the ECB is reluctant to do. Action to recapitalise the region’s banks could also help boost confidence, although this also faces serious challenges.
Share prices certainly look reasonable when measured against long-term company profits. Provided we don’t enter a global recession then markets may offer some long-term opportunities. However, given the large amount of risk in markets at the moment, we advocate a cautious approach.
How are you positioned in this environment?
NG: We have increased our exposure to government bonds, particularly to bonds with longer maturities given the US Federal Reserve’s recent announcement of Operation Twist, in which it will purchase long-dated Treasury bonds.
TS: Stock markets remain uncertain. Share prices are not being driven by valuations but by speculation over European policy announcements. We are therefore maintaining low exposure to stock markets given the treacherous environment.
We are more positive on bonds and bond returns may continue to surprise as growth disappoints in many western markets. We particularly like the UK Gilt market for this reason.