Author: Atlas Capital
The economic climate will continue to be challenging in the European Union throughout 2012. European equities are fundamentally very attractively valued, but we are currently underweight primarily because of the uncertainty surrounding the continuing viability of the Euro, tied to the failure of a politically fractured EU to manage over its levered member states.
To us, what is required is a combination of debt forgiveness, fiscal discipline and a central bank willingness to act as buyer of last resort. The weaker, or over-levered nations (Greece, Ireland, Portugal, Spain, Italy) are, and will continue to be, unable to repay their sovereign debts. Many of these debts are to the stronger nations and their banks within the EU. Debt forgiveness will result in massive losses for the financial system and such fears have periodically contributed to the liquidity shortages seen in the European financial system over the last two years.
We are not optimistic that a political solution can be delivered, but at least we’ve begun to see the ECB act as the provider of liquidity needed to weather the financial storm. Assuming the EU does in fact lay the groundwork of debt restructuring/forgiveness with a credible liquidity backstop provided by the ECB, the EU will still need to impose some sort of coordinated fiscal discipline on its member states to give global investors confidence that the Union and the currency can survive its first significant financial crisis.
Failure to implement this 3-part solution will inevitably result in some defaults and a real risk that several states fall out of the Euro. Such an event will create substantial psychological pain, but will violently start the cleansing process. It’s up to the leadership on the Continent which path they will follow. We will wait for more clarity before changing our underweight perspective.