We are monitoring Greece events closely, but the volatility it is causing will not derail the European recovery elsewhere. Should the referendum approve the creditors’ package we expect markets to rally sharply.
Volatility will remain elevated while investors assess the likely path of the referendum. Opinion polls at the weekend, taken before the referendum announcement, showed continued support for Euro membership, even if it meant implementing the package proposed by the creditors. This means that both sides in the negotiations wish to see Greece remain a eurozone member.
The contagion risk from Greece is limited: ownership of Greek bonds is concentrated in the hands of official institutions, and this can be seen in the huge fall in the outstanding volume of Greek CDSs, from around €65bn in 2009 to around €1.5bn now. Eurozone banks are not lending to Greek banks in the interbank market, and Greek bonds are ineligible as collateral, so the risk of a failure of confidence in the financial system is low. Coupled with this, the ECB now has the tools it needs to limit contagion, and a potentially unlimited balance sheet.
Greece notwithstanding, we’re optimistic about European equities. This view is founded on a recovery in growth in 2015, fuelled by an end to fiscal reforms, a recovery in credit after the successful recapitalisation of Europe’s banks, and a recovery in corporate earnings.
Syriza complain about the policies enjoined upon them by their creditors, but other countries which have embraced reform have recovered successfully: indeed Spain and Ireland, which implemented reforms early, are now two of the fastest growing economies in the Eurozone, while Portugal, which also reformed in 2012, has been growing for the last 6 quarters. A year ago Greece, having implemented reforms late, was growing at around 1.5%, with a primary surplus, and had regained market access, issuing a €4bn 5 year bond at 4.75% in April 2014. The election of Syriza has caused a collapse in the Greek economy, with tax receipts falling short of target, the primary surplus evaporating, and the banks now shut.
Outside of Greece, evidence that the European recovery remains robust can be seen from manufacturing and services confidence indices, steepening yield curves, rising money supply (which is a good lead indicator for corporate earnings), and falling unemployment.
Stephen Macklow-Smith is head of the European Equities Strategy Team at JP Morgan Asset Management