FOR watchers of global stock markets, it has been an exhausting few months.
The time honoured phrase, “sell in May and go away” would have applied well again this year, with global stock markets having fallen by over 6% from the end of April to the middle of July.
The experience has however been far more enervating than the usual summer doldrums.
Investors’ blood pressure has been raised by the re-emergence of systemic risk – the possibility of more than a cyclical set back – which would be the likely consequence of failure by European governments or by the US Congress to deal with the problems of, respectively, the eurozone and the US debt burden.
It is of little comfort to observe that when large political changes are contemplated, it often requires a sense of crisis to achieve consensus. The process of reaching such consensus may be uncomfortable to watch, but it should be true that if the consequences of not doing so are unambiguously negative, a viable solution is likely be found.
Today, although there will always be vocal minority elements expressing opposition to any potential compromise, all the key participants in the debates in Europe and America are certainly aware that the consequences of not reaching agreement are likely to be far worse than those of agreeing to solutions that may be politically awkward.
This prognosis of the course of events appears to be borne out by the most recent experience in Europe, where politicians received their wake-up call two weeks ago when Italian and Spanish debt yields began to follow the path of Greece, Ireland and Portugal. Their response in creating a prototype European Monetary Fund by giving wider powers to the European Financial Stability Fund (the EFSF) has been broadly positive.
Even if the treatment is still incomplete (many view the current lending capacity of the EFSF as insufficient) Greece’s debt burden has been materially restructured, with some spin off benefits for both Ireland and Portugal. Furthermore, compromises between France, Germany and the European Central Bank (ECB) on private sector participation and a reaffirmation of the inviolability of the ECB’s balance sheet should be stabilising factors.
So now the spotlight moves to America. Since the recalcitrance of the Republican segment of Congress became fully apparent in April, markets have nevertheless assumed that ultimately fiscal conservatives would back down, allowing a raising of the debt ceiling for a reasonable political price.
If reports from Congress are correct however, it appears that there may be a segment of the innocuously named “Tea Party” faction who either fail to understand the implications of a US default, or who welcome the chaos that it would precipitate.
We still firmly expect a solution to be found. President Obama has offered sensible compromises and voters’ dissatisfaction with Republican brinkmanship is rising. In the words of Calvin Coolidge, “the business of America is business” and congressional deadlock is beginning to threaten this inviolable principle.
Provided we are right in our optimism, the investment clouds could rapidly clear. Judging by recent employment data and the second quarter earnings season to date, the corporate sector remains in robust health and is looking across the valley of current political uncertainties to a more favourable second half beyond.
It is now for politicians to avoid snatching defeat from the jaws of victory.
John Haynes,
Head of Research,
Investec
