Why Olympic Success Must Inspire Action in Europe

Central banks are running out of steam as their measures to bring calm back to markets are no longer as effective as they once were. Germany too seems unable to keep up. Like a marathon runner caught in a sprint, their reluctance to move forward stands in stark contrast to market moves focused on the end game. But the road isn’t clear. Europe has three remaining hurdles in their race to recovery: funds, fiscal unity and reform. With Greece approaching the final whistle, doubts over its ability to stay within Europe are growing louder. The worry is investors are watching the referee not the striker, more focused on the search for safety than the rising risk elsewhere in the markets. False starts continue to drive market volatility and while investors ask whether it’s time to back the ‘underdog’, European stocks may provide diamonds in rough, but things could get rougher.

Watch the debate in a quick CNBC clip:

How Europe’s Crisis is Like the Olympics & How to Trade These Markets

 

Central Banks: Running out of steam

The vital relationship between central banks implementing stimulus and Spanish yields falling has broken down since April of this year. No longer is central bank action able to reassure the market and instead Spain and Italy’s borrowing costs remain at elevated levels. Investors are demanding more. Structural change is needed but markets are concerned that leaders could choke under the pressure.

Germany: A marathon runner caught in a sprint

Germany wants to progress towards greater unity at its own pace but the markets move faster. Indeed a backbencher delivered his dissatisfaction with the European Central Bank’s plans to their Constitutional Court! It will be tackled in September but investors and the economy won’t wait. Weak consumer confidence and rating agency scepticism highlight the urgency for action.

Europe: 3 Hurdles in Race to Recovery

The three key obstacles to be tackled to progress towards stability are: enough funds to contain the crisis; fiscal consolidation (share budgets in order to share debt burdens and be able to offer ‘eurobonds’); and finally structural reform to regain competitiveness & growth. All are vital for the future of the region and this realisation is starting to build within the markets. Europe did manage to overcome their concern that a Fed-Style straight bond buying programme would reduce the pressure on countries to reform, with a Memorandum of Understanding putting these measures on paper. The use of ‘MOU’s in order to accept ‘IOU’s to lend to countries within Europe may be a step forward, but this remains only part of the full picture needed for longer-lasting results.

Greece: Approaching the Final Whistle

S&P ratings agency has questioned whether Greece will be able to secure the next tranche of bailout funds as it downgraded the outlook for its credit rating to negative. Without such funding, the ‘death knell’ for Greece’s euro membership will be sounded. With the IMFsignalling payments to Greece will stop, the lack of funding fuels fears that without drastic action, the end could be near. Even beyond Greece, the Italian Prime Minister dared to publicise the possibility of a Eurozone breakup if borrowing costs did not fall.

Investors: Watching the Referee not the Striker

The rush to safety has been overshadowing rising risksAs investors pile in to perceived ‘safe haven’ assets, the yield on German government bonds has been falling. However, in a different market, the cost of insuring these bonds has risen as these investors see risk on the rise. The snapback in bond markets to better reflect this sentiment could shake the equity market as well and is therefore a significant concern.

Markets: False Starts

Markets have rallied in the face of disappointing data. Eurozone stocks reached a 4 monthhigh as manufacturing dropped to a 3 year low suggesting the slump is extending into Q3. This discrepancy has driven market volatility, exacerbated by the low volume of shares traded over the summer months. Greater clarity is required to see a more sustained upward momentum which will have to wait until leaders are back from their hols!

Investments: When to Back the Underdog?

European stocks may provide diamonds in rough, but things could get rougher. The overweight US / underweight EU trade is starting to look stretched, as the divergence in performance between the two regions continues to increase. This has been quite understandable, but there will come a time when this is overdone. Within Europe, there are international companies, with geographically diversified revenue streams so not dependent solely on domestic demand for their products or services. Furthermore, with effective management teams and strong fiscal positions, some may be starting to look cheap. However, cheap could get cheaper. Damage to sentiment could lead to market punishment regardless of fundamentals. Therefore waiting for decisive developments & clarity on road to recovery may be prudent.

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