As the European sovereign debt crisis continues, forecasters are suspecting that the only realistic long-term solution may be a breakup of the eurozone.
In a conference call hosted by the Bank of Montreal on Thursday, Tony Cousins, chief investment officer at London, England-based asset management firm Pyrford International Ltd. offered a dim outlook for Europe for 2012.
“We do think that Europe is going to have to go through some immense turbulence this year, and even beyond,” Cousins said.
As the region deals with mini crises week after week, he says policymakers will eventually be forced to find long-term solutions to the underlying problems in the eurozone.
“The core of the problem is that the periphery of Europe – and particularly southern Europe – is totally uncompetitive versus northern Europe, to the tune of around 30%,” Cousins explained.
The lack of economic growth in these uncompetitive peripheral countries makes it hard for them to tackle their soaring debt loads. In order to improve their competitiveness, Cousins said they must either deflate wages or devalue their currency. Since wage deflation is an unpopular and economically painful process that would take roughly a decade, Cousins said the most obvious long-term solution is for Greece and other peripheral countries to exit the euro monetary union.
“What we see these economies actually needing to do is to get out of the euro,” he said. “That is what we think the end game is here.”
Cousins expects Greece will be the first country to leave the euro, and he hopes this will happen in conjunction with an orderly default. A disorderly default, he noted, would present a major risk to the financial system.
“We don’t want banking systems to freeze up,” he said, “so it’s in everybody’s interest to avoid that eventuality.”
Andrew Busch, global currency and public policy strategist at BMO Capital Markets in Chicago, agreed that if a default occurs, it’s critical for policymakers to ensure it’s as orderly as possible.
“A messy default would be the worst possible outcome for Greece,” Busch said.
Economically, Busch expects flat growth for the eurozone this year, with particular weakness in the first half of the year.
On the debt front, he said he was encouraged by Spain’s bond sale on Thursday, which was more successful than expected. However, with about US$1 trillion in sovereign debt coming up for refinancing this year – much of that comprised of French, Italian and Spanish debt which matures in the first quarter – he said it’s too soon to tell whether this level of investor appetite will continue.
“The real proof in the pudding will come by the end of the quarter,” Busch said. “Early, it looks good, but I would say you’ll probably get investor fatigue at least by mid-March on the amount of debt that’s out there.”
Against this backdrop, portfolio managers are positioned very defensively. In fact, Cousins said Pyrford International’s portfolios are more defensively positioned than they’ve ever been since he joined the firm 23 years ago.
“The valuations prevailing in the market simply haven’t discounted the full scale of these risks,” he said.
Paul Taylor, chief investment officer at BMO Harris Private Banking in Toronto, said he continues to favour defensive sectors, such as consumer staples, telecommunications and utilities. He expects to see modest earnings growth of 5% to 7% this year.