ALTHOUGH volatility has continued to make the journey uncomfortable, since the lurch downwards in stock markets at the beginning of August, in the wake of the Standard & Poor’s decision to downgrade America’s credit rating, market index levels are little changed.
This partly reflects the fact that, while there has clearly been some real world economic impact from the political dithering in both America and Europe at the end of July, so far it is not threatening to become self-reinforcing. Consumer and business sentiment have been damaged and employment growth has stalled, but even though stock and bond markets are united in fearfulness, there is little evidence that multinational corporations are clambering back into the defensive bunker.
This is a hopeful sign that an optimistic assessment of the resilience to the current business cycle is justified – supported as it is by solid global demand patterns, high corporate profit margins, strong private sector balance sheets, low financing costs and a better capitalised, more transparent banking system.
It suggests, most importantly, that a period of calm without adverse political developments could quickly see a return of the animal spirits that appeared to be taking the lead early in 2011. This was before those spirits were dampened by the triple-whammy of an oil price spike driven by Middle Eastern turmoil, the Japanese tsunami’s negative impact on global demand and supply chains and America’s breathtakingly self-immolatary Congressional financial brinkmanship.
Aside from the euro-zone situation, all of these roadblocks appear to be behind us. Unfortunately, this is the biggest roadblock of them all and the measures recently put in place to secure liquidity to the banking system, if not accompanied by a long-term solution, merely put off the inevitable judgment day.
As we look at the euro-zone situation today, with Italy now at the core of the current market unease, we appear to have reached the nub of the problem. Italian bond markets’ misbehaviour is of far greater import than previous experiences in Greece, Portugal, Ireland and Spain. Germany must decide whether it has the stomach to underwrite Italy’s commitment to fiscal prudence and specifically southern Europe’s largest debtor nations’ commitment to collecting taxes. This would be signalled by empowering the European Financial Stability Facility – or the European Central Bank (ECB) – to buy unlimited amounts of their debt, and it is the minimum price of sustaining the euro in its current form. To be doubly sure, in spite of the objections from European Central Bank president Jean- Claude Trichet, a recapitalisation of euro- zone banks should also be put in place.
We continue to expect Europe will find a solution, but it is clear the political challenge in doing so is great – hence, the sense of crisis necessary to precipitate a consensus. Judging by the open warfare in the press, both within Europe and between the ECB and the American treasury, a cathartic moment may soon be upon us.
John Haynes,
Head of Research,
Investec
