The global outlook remains challenging as the effects of the Eurozone sovereign debt crisis continue to be felt around the world, with the recent G20 summit in Mexico dominated by finger-pointing from either side of the Atlantic. Despite a bail-out for Spain’s struggling banks and political progress in Greece, we seem to be no closer to a resolution.
The Eurozone’s problems are so deep-rooted that a speedy solution was never likely. Indeed, they have been plaguing the single currency area since the birth of the euro. However, there has been progress of sorts over the past year. The region’s liquidity crisis looks to be con-tained for now, aided by the concerted efforts of author-ities to f lood the financial system with cheap funding.
However, there is a long way to go in terms of govern-ments cutting their fiscal deficits, as well as labour and financial market reforms, all against the backdrop of a drawn out period of weak economic growth. As such, there seems to be some way to go before the overall crisis comes to an end.
Contagion risks
Meanwhile, in the UK, households have been feeling the pinch for some time now, so a return to recession in the first quarter of the year came as no great surprise. How-ever, the problem is the uncertainty surrounding a return to positive economic growth, its drivers and the speed at which a recovery gathers pace. The UK government can attempt to cut its deficit and encourage domestic growth but ultimately the country’s growth prospects are heavily entwined with those of the Eurozone and a further wors-ening of the single currency area’s problems is likely to affect the UK; something the government and the Bank of England have limited policy tools to manage.
Elsewhere, investors continue to keep an eye on China and the prospect of a hard economic landing. With GDP growth showing signs of slowing, Chinese authorities are taking a proactive approach in an attempt to boost growth with cuts to its banks’ reserve ratio require-ments, as well as the big step of cutting interest rates in May – the first time this has been done since 2008.
Are emerging markets immune to the Eurozone’s problems? In short, no; this is not because there are cur-rently any major sovereign concerns in those areas but simply because globalisation means a much greater eco-nomic interconnection between geographical regions. While many emerging economies are supported by robust domestic consumption, they are still, to varying degrees, reliant upon the economic and financial sta-bility of the developed world.
Guarded optimism
The US economy is certainly looking somewhat healthier than those across the Atlantic, with positive, albeit sub-trend, economic growth numbers and stable employment. However, it is by no means out of the woods yet, indeed recent data have suggested a weakening in economic con-ditions.
Both sides of the US political spectrum have parked the issue of reducing the country’s vast debts until after this year’s Presidential election but this is expected to be addressed at the start of next year. The approach taken to tackle this issue is bound to have an impact upon financial markets and investors.
In the meantime, with investors preoccupied by the Eurozone crisis and its potential resolution, there has been little focus on the ramifications of political change and even potential international intervention in the Middle East, a move which would likely lift oil prices. So while we are generally optimistic about the US investment environment, it remains vulnerable to the problems being encountered in Europe and it therefore seems inevitable that there will be further bumps in the road to its economic recovery.
However, these concerns must be tempered by the fact that, despite the significant efforts thus far, there remains scope for, and willingness from, authorities around the world to take unprecedented steps to further stimulate growth should the need arise.
Uncertain times
Market uncertainty tends to mirror uncertainty in the real economy, so volatility looks set to become a perma-nent fixture. There has been much political instability in Europe so far this year, with political change already having taken place in France, the Netherlands and Greece, questions being asked about whether the pro-austerity stance of the Eurozone’s authorities should be maintained, and question marks over the future of the single currency. These economic concerns are likely to drive financial market volatility for the foreseeable future.
In terms of a suitable investment approach in this environment, a greater focus on capital preservation at the expense of chasing significant returns seems sen-sible. With economic growth oscillating between slow and slower, and markets remaining skittish, investors need to be smart about positioning themselves for both good and bad news.
There is much doom and gloom surrounding the global economy and financial markets, but there is cer-tainly some cause for tempered optimism. In the short term, we believe optimism should come in the form of the investment opportunities that will emerge as a result of some of the ‘abnormally low’ asset valuations that can be found. Over the longer term, while this tran-sitional process will undoubtedly be long and painful, when we emerge on the other side we are likely to find a financial system that is better regulated, less burdened by debt, more transparent, with greater liquidity and with banking reforms in place.
