The last week has seen some positive, or more stable moves, regarding Italy, Greece and Spain and the political games which have been surrounding these countries and the state of their finances.
I attended a teleconference with a a top economist at JPMorgan in London on Friday morning last week and will relay a part of the information below for those of you incertain about the current economic climate.
The general feeling from the frontline is that there is unlikely to be any imminent breakup of the Euro despite what you may read in the headline grabbing newspapers. However, you can be assured that you will continue to see volatility in the markets for some time to come until the markets are happy with the economic reforms which are being put in place in Italy, Spain and Greece.
If we take Italy and Spain specifically it would seem that the recent Bond market activity, which pushed Italy’s yield to over 7%, is actually unjustified and is more of the Bond market demanding change at a political level (i.e the resignation of Berlusconi) and urgent reform which is desperately needed. The facts are that both Italy and Spain are NOT insolvent. Italy in particular is actually quite a buoyant economy.
If you take the Gross Domestic Product of Italy before it has to make interest payments on its Government debt, it actually runs a primary budget surplus. This is NOT the case with Ireland and Greece.
In effect, all Italy has to do is make sufficient reform by raising taxes (arrgghh), pension reform and labour market reforms and it could be one of the more secure members of the Euro block. It is easy to forget that Italy is actually the worlds four largest manufacturing economy behind, China, USA, and Japan.
Before I move onto less Italian specific details it is also worth noting that the media talk of a 7% interest rate on Italian debt being a ‘critical level’ over which they would likely default, is actually nothing more than media hype. A 2% increase in the yield on Italian Bonds equates to a further €7 billion in annual interest payments which in turn equates to only 0.4% of the Italian economy GDP. Also, Italy lived with Government Bond yields of 6%, 10 years ago and 12% in the 1990′s. So to repeat the message from above. Reforms are needed to change the outlook for Italy as a whole, but we have not hit critical levels just yet.
The great thing, in my opinion, is that whilst European politicians continue to play games and show an inability to co-operate for the greater good of the people, the Bond market will ultimately dictate the speed and depth at which the reforms take place. Hail the Bond Market! The other positive news is that Mario Monti is actually making all the right noises and so far is being seen as a beacon for positive change by the markets.
All this being said, there is the distinct possibility that the failure to reach a consensus in Europe could cause a run on the banks, potentially bringing down the banking system in Europe and having a knock on effect across the world. However, we see this is a less likely scenario at this time.
So onto the EURO! Will it survive its first real crisis?
Well, the strength of the EURO versus the USD and other currencies certainly has had me and a lot of you guessing for some time. However, after the teleconference with JPMorgan it would seem that the experts think that the Euro on a trade weighted basis against the USD is in an acceptable zone, +/- a percentage (which is anyone’s guess).
The failure of the Euro to depreciate against the USD would seem to be a recognition by the markets that Europe will in fact works out it problems. The Euro doesn’t appear to be at risk at the moment.
For this to continue we will have to see continued reforms in Italy, Greece and Spain and Ireland. This is now highly likely with the very Pro European governments which are in place in each country respectively. In addition, whilst the respective countries make reforms as per the EU demands, the EU itself will continue to buy single country Bonds to maintain liquidity and in turn this will prop the EURO currency up against others.
On the negative side, as a result of the recent delaying tactics in Europe, most European countries will fall into recession in the coming months, for a few months at least, and then return to growth, all be it anaemic.
So, to sign off from this e-zine I will add some other points from the teleconference which arose, namely:
1. The USA is in quite good health economically speaking and a double dip recession is unlikely now. The drag is the housing market, otherwise companies are in healthy shape and starting to hire employees again.
2. Holding money in cash right now is a clear way to wealth/savings destruction. With the increasing costs of living,( currently 4%p.a in Italy), holding cash is missing out on excellent investment opportunities and without having to take lots of risk in the stock market.
3. Equities are likely to be the out performers, as an asset, over the next 1-5 years. The volatility will be high, but returns could be favourable compared to cash, Bonds and other assets.
4. Whilst the developed world flounders in debt, the developing world is continuing its speedy pace to global dominance. The historical view has been that investing in emerging economies has always been more risky than investing in developing economies. In the present climate that trend has reversed, although it is anyone’s guess how long it will continue.
5. And finally, Industrial metals prices are expected to continue climbing as China, in particular, grows its way to global dominance. As with all assets, at the moment, the gains will be achieved with high price volatility.
Where possible, I will be attending the JPM teleconference once a month and will relay the info from it.
As usual, if you would like to learn more or are interested in exploring any of this material or personal finance in general then contact me on firstname.lastname@example.org or call me on 3336492356.