- The current European market environment is mainly concerned with the questions: Is this the end of the crisis? Will the crisis worsen with one of the weaker countries unravelling, sending Europe into a even deeper crisis?
- Our base case is that Europe will pull through. We believe that during muddling through, banks will strengthen their balance sheets through high credit spreads, by not paying dividends and by writing off the bad debt. Governments will slowly address the structural issues. Companies will restructure where necessary and at some point when the recovery comes, consumers may have some pent-up demand that needs satisfying.
- Muddling through however requires that a number of problems don’t surface:No Eurozone country goes into default. It looks like this has been averted but policy failures by a government could spark a crisis.The banks remain solvent, meaning the bad debts can be written off in a gradual manner and not in one go. The fact that the large banks will be put under ECB supervision poses some short term risk as it may highlight problems, perhaps triggering a need for public support to bolster its balance sheet or mean a curtailment in lending as banks try to meet the ECB requirements.
- On the longer term it should lead to stronger banks, a level the playing field and decouple banks from national finances.A downturn is not simultaneous everywhere but that some Eurozone countries continue to show growth. In any case a muddling through means that we probably have another 5 years or so before a clear recovery takes place.
- The stress in the market will move from place to place as an issue is resolved in one area to lay bare an issue in another. We will continue to oscillate between hope and fear. Markets will also be volatile as people will too early in thinking everything will be better and too pessimistic at each setback thinking the recovery will not take place….
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