Friday, 22 June 2012

Week in Review: High stakes at Euro 2012

"Be happy dear Greeks, the defeat on Friday is a gift” read the headline on the front page of Bild, the German tabloid. “Against Jogi Loew [the German coach], no rescue fund will help you." 

In every way this evenings’ quarter final match-up between Germany and Greece looks like more like a mismatch. According to FIFA, Germany is the third best team in the world, whereas Greece is arguably punching above its weight to secure the 14th ranking.  Amazingly Greece won the tournament in 2004; an achievement made possible by their German coach, Otto Rehhagel.  An example of what Greeks can achieve under German leadership? Few Greeks would agree. 

Germany, of course, has many advantages over Greece.  With a population around eight times higher they can pick from a larger pool of players.  Added to which they have a fine footballing tradition which has seen them claim three World Cups and three European Championships.  Against this the Greeks can argue that they invented football, although some might point out that the same could be said for democracy and economics where they now seem to have lost their way.

The disparity between the two nations’ footballing prowess is a fraction of their economic polarisation. Germany is the 6th most competitive country in the world, while Greece languishes in 90th place.  If you run the Google public data explorer below you’ll see that since 2005 that competitiveness gulf has widened rather than converged within the European currency union. 

Therein lies the eurozone’s flaw; while countries are allowed to maintain fundamentally different ‘supply sides’ (labour laws, tax rates, investment rates, legal protections) they will diverge economically regardless of whether they share a currency and interest rate.

Yesterday the IMF released their prescription for a eurozone panacea. Whilst maybe not inspired by mine there is significant overlap! Both require more action from the ECB and more structural reforms. The areas of difference are things like eurobonds which I still harbour reservations about – they provide little benefit in the short term and carry pitfalls which I discussed before. In general the IMF route imposes further restrictions on members whereas I believe providing incentives is a better route.

The equity market was reasonably robust this week considering economic news was, on balance, disappointing.  In Europe a positive surprise for French Purchasing Managers Indices was offset by negative surprises from Germany – even the German service sector is now on the verge of contraction.

Source: Brewin Dolphin/DataStream
The HSBC Purchasing Managers Index for China also disappointed.  Whilst the modest contractions remain consistent with a soft landing it does seem that the awaited reacceleration may be further away than anticipated.
Data from the US was more mixed.  Employment and some survey data was a little weak however there was more encouraging news on the house prices (which rose).  

The US housing recovery and recent growth in homeowners’ equity are supportive of banks although that didn’t stop Moody’s from downgrading the credit ratings of 17 banks based upon the risk they incur through their exposure to securities markets. 

Source: Brewin Dolphin/DataStream

Despite the negative newsflow, in fact almost because of it (as we noted last week, weak is the new strong), investors bravely set about conquering the wall of worry as the prospect of quantitative easing appeared on the horizons of the UK and US.  The Federal Reserve downgraded their own economic forecast and extended their Maturity Extension Program (so-called Operation Twist) whilst signalling that they stand ready to act should conditions deteriorate further.

The Bank of England meanwhile released minutes showing a rising disposition towards further quantitative easing. So much so that the Governor took the unusual step of voting against the consensus (as he always votes last he can effectively choose whether to win or lose the vote). By aligning himself with the dovish minority he sends a powerful message to the markets that the Bank is debating when to ease, not whether to ease.

And so concludes another frenetic week in the financial markets with the FTSE finishing barely changed.  This time next week we will be looking forward to the Euro 2012 final on Sunday. The bookies expect it to be between Spain (who are expected to officially ask for a bailout on Monday) and Germany (who are expected to provide it).

Guy Foster
Head of Portfolio Strategy

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