One way to visualize what is happening in this latest round of Euromarket jitters is to look at the present disparity in returns among European stock markets. Sweden and Denmark, both non-Eurozone countries (i.e. they continue to use the Swedish krona and Danish krone respectively), are at the top of the tables with year to date returns in the neighborhood of 25% as of November 12. Germany, the Eurozone’s putative anchor of stability, is up 8.2% YTD (also as of November 12) while other relatively stable markets like Belgium, Austria and the Netherlands are in low-single digit territory.
Then the bottom drops out with the Not-So-Fabulous-Five: Portugal, Italy, Spain, Ireland and Greece cover a spectrum of returns from -6.5% (Portugal) to -37.0% (Greece) as of 11/12 year to date. The EU, the world’s second-largest economy when aggregated, is bookended by countries whose national currencies are not directly affected by the fate of the Euro on one side, and the countries that actually could determine the currency’s fate on the other side.
This is the background context for the latest slings and arrows to rail at the ramparts of Fortress Europe: these being of a decidedly Emerald Isle flavor. As we write this the consensus appears to be forming around the conclusion that Ireland will require a financial bailout to the tune of $100 billion give or take. A “technical team” is in Dublin now to review the details, even as the Irish government continues to dissemble about not actually-really-totally needing the bailout just yet. As yields on Irish government debt rise to record levels this appears to be Act III of the Greek Tragicomedy of 2010, with Acts IV and V (Spain? Portugal? La bella Italia, cosi fan tutti?) plausibly waiting in the wings. You will recall that Greece’s woes catalyzed EU policymakers and central bank authorities to mobilize €750 billion earlier this year, and the Irish bailout, should it proceed, would be drawn from those funds.
This time around there is less genuine fretting among observers that the Eurozone is teetering on the edge of the abyss – the stability of the currency does not appear to be in doubt. Actually, the fiscal house of Europe is in better order than those of either the US or Japan, and from our standpoint there appears to be a greater level of seriousness among EU policymakers in addressing the crisis than could be said of their colleagues in Tokyo or Washington. Having said that, there are sharply defined tensions among Eurozone countries, with most of the ill will being directed at Germany. The Germans have been constant critics of the bailout from its early days, and recent days this criticism has sharpened around the notion that public funds from the bailout should ensure the return of 100 cents on every euro held by private bondholders. The sharp rise in Irish bond yields reflects in part a concern by would-be investors that a bailout might fully compensate them in the event of a default. From their side the Germans argue that private investors need to wean themselves from those warm and fuzzy guarantees of full compensation they have become so used to hearing. Sound familiar? Debates over the Greenspan/Bernanke put are an ongoing feature of discourse on this side of the jet stream.
All of this matters greatly from an asset allocation perspective. We have been used to a world defined by two flavors of non-domestic investments: “developed international” and “emerging markets”. The topography of the real world is considerably more complex than that. You can’t really look at the EU as one “asset”, for example, when you have such fundamental disparity between the economic strengths and weaknesses of its member countries. EAFE – Europe, Australasia and Far East – is hardly an adequate benchmark for international equities when it includes nearly-insolvent European states alongside the high-growth markets of Pacific ex-Japan. The job of making intelligent portfolio allocation decisions becomes ever more challenging – and we believe there are opportunities amidst the chaos.