Global markets: Dollar under pressure?
John Walsh analyses the global market implications for the euro zone sovereign debt crisis.
Equities have experienced a bout of huge volatility since the start of this year. The market nosedived in February which was followed by a few months of robust growth with equities hitting pre-February highs. But the sovereign debt crisis in the euro zone changed all of that. "What we have is a market neurosis, with the euro the top of the agenda," says Bernard McAlinden, chief investment strategist at NCB Stockbrokers.
There are also concerns about the rate of monetary tightening in the Chinese economy which has the potential to put a brake on growth in the biggest emerging market economy, which is responsible for dragging up world growth. Moreover, the rate of fiscal tightening across all major economies over the medium to longer term will have massive implications for equities.
"But the main worry remains the threat of deflation in peripheral European countries and whether this has the potential to lead to another banking crisis," says McAlinden. He argues that the EU authorities have enough levers to prevent a banking meltdown. "But the problem is that global equity markets have not learned yet how to live with deep problems in the periphery of the euro zone"
McAlinden favours a move into defensive stocks: energy, pharma, utilities and telecoms. He says that of the four sectors, pharma and energy offer the best upside. "Yields in these two sectors are running at 6-to-7%, whereas the yield on a 10-year German bund is 2.6%."
Notwithstanding the current market turmoil, McAlinden believes that an underlying cyclical bull rally is still in place, although the market could move sideways for most of this year. Moreover, the euro's weakness will help boost exports and give the region's economy a lift. His advice to investors is to keep away from stocks and sectors that have exposure to euro zone peripherals.
"If you want to drain a swamp, you don't ask the frogs for an objective assessment," was the view of Wolfgang Schäuble, German finance minister.
The quote may seem a bit cryptic from the normally direct German minister but the statement was made in response to his government's ban on naked short selling. The move caused market chaos as it was introduced unilaterally and without the approval of its EU neighbours or the US.
The argument for short selling is that it increases liquidity, aids price discovery and helps highlight underlying problems. For example, the argument in favour of short selling is that this type of market activity did not cause the Greek debt crisis - years of profligate spending and indiscipline was responsible for that. But the shorts in the market helped highlight the economic train crash that was unfolding.
The Germans have taken a very different view. They argue that naked short selling, which means that investors do not own the underlying asset they are trading, distorts the market.
One Dublin-based investment manager is taking a contrarian view to the market and supports the German stance. "All this criticism of the German move is coming from the market and what that means is that it doesn't suit the market. We have to get rid of this whole short-termism and short selling is a big part of that. It is just speculating and that is no good."
He says that the market downturn on the back of the German policy initiative stemmed from US investors dumping European stock on the basis that the euro was edging closer to a break-up and the weakness of the single currency which was affecting their short-term performance.
Similar to McAlinden, he argues that there is an upside for the euro. "If the Greeks are kicked out, that will make it stronger. If they accept the fiscal austerity measures, then that will also make it stronger. What is happening at the moment is effectively a competitive devaluation similar to the dollar last year which boosted the US economy."
Indeed, if anything, there are now concerns about the US economy and the consequences for equities on the basis that the weak dollar gave a huge fillip to the economy in 2009 but that has now been removed, which will test the durability of what is seen as a fragile recovery.
The investment manager plans on staying in cash until August before hopping back into equities.