The euro crisis is playing out like a couple stuck in a bad marriage. When the relationship first seemed to be struggling, they try to make things better by getting married.
When this didn’t work, they decide to see if having children will help.
Europe’s move from a free trade area to a currency union has hit the rocks and now the authorities must decide if fiscal union will save the day. This may succeed in trapping Europe in an unhappy union but the markets seem to be telling them that the time has come to move on.
On emerging markets:
For the broader emerging markets, the growth outlook, demographics and government balance sheets look a picture of health in comparison to the developed world. However, the level of confidence in these economies should be considered a reason for concern. Issues of weak government institutions, corruption and poor corporate governance tend to get overlooked when times are good.
Current government bond yields sit at the low end of their historic range across the emerging world, which highlights that confidence has rarely been higher. Indeed, emerging market debt funds have seen record inflows over the year to date. Yet a number of emerging currencies have suffered significant falls and the risk premium relative to US treasury bonds has increased. Our exposure to emerging debt and currency markets is through a manager who is cautious on the broader asset class and focussing on a small number of markets where they can find value and sentiment is more balanced.
On China:
Over the next few years, China faces two key challenges. It must shift from a largely export-led economy towards domestic demand-driven growth. It must also move towards opening up its financial markets and many crises around the world have been triggered by deregulation of the financial system.
On gold:
Gold continues to look expensive but will remain so due to unsustainable government finances across much of the developed world. During these times, investors seek safe havens in both gold and the dollar. As the crisis in Europe intensifies, the odds on an extreme outcome increase.
Gold shares offer value and can soar in a scenario where slowing global activity leads to lower oil prices, cutting costs for the miners, while rising fears of chaos push up the price of gold. US oil inventories have risen to recent highs, making the oil price vulnerable as economic data continues to disappoint.
Conclusion:
Right now we are faced with the uncomfortable combination of extremely oversold markets and a number of signals telling us it is right to panic. This leaves us poised for a rapid rebound if anything is done to restore confidence but vulnerable to accelerating downside if authorities remain on the sidelines. Politics will determine where we go next.