Charity begins at home
It should be remembered that Spain and Italy were heavily supported by their local bond markets when foreign owners left and even increased their holdings in 2013. This provided stability of the market and is seeing some investors returning now.
These economies also face different economic challenges and in a common monetary area without their own fiscal freedoms, they rely on government institutions to create effective change.
Many of the periphery economies have been praised for making change and all have moved from positions of large current account deficits to balance or even surplus. These economies are again lending to foreigners and this fundamental change is sustainable as they are not chasing foreign capital.
But it would be foolish to consider this the end of the bad days, warns Conning’s Hawkins.
“Debt to GDP levels are high, particularly in a number of countries slow in adopting reforms, such as Italy. If you look at using core markets, Germany is currently at 1.3%. Spread contractions of government bonds and in credit markets place pressure on investors in the hunt for yield.”
The time to reform is now
The market should not allow euphoria to take its eye off the ball when it comes to pricing risk, a message relayed recently by the Fed’s Janet Yellen when talking about high yield markets not accounting for all the risks.
Wouter Sturkenboom, investment analyst at Russell Investments, admits he and his colleagues are getting more cautious with regards to the periphery.
“The improvement has not been in line with pricing in the market and it’s not quite what we would call representative,” says Sturkenboom. “Embedded credit risk is all about growth and inflation and condor whether the high levels of government debt we have feel is compensated in the underlying pricing.”
Sturkenboom focuses mostly on Italy and Spain because the other main economies of Ireland and Portugal are considered a little small.
The situation may remain stable if these economies continue to take their medicine. Spain, Portugal and Ireland have done the most, with Ireland being the most zealous. Italy has done the least, riding domestic support and to some degree its luck, having slipped back into recession for the third time since 2007, according to GDP figures released early in August.
Whether any of these nations have learned their lessons, only time will tell. These economies are still not strong enough to endure a long-running crisis, but it is not only the periphery we should be watching out for, says Gareth Colesmith, senior portfolio manager at Insight Investment.
“With support, they could experience a period of growth, reduce their debt burden and should then be okay. The focus may then shift to France,” he suggests. “France has not had the pressure to make reforms. Though it understands the need, it can’t make a case with the electorate and there isn’t the same political demand.”
France is likely to coast along until the next recession, which could then find it in considerable trouble.
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