By David Absolon, Investment Director at Heartwood Investment Management
A Syriza election victory would obviously increase Greek credit risk – i.e. the higher probability of a country default – and raise concerns of a Greek exit from EMU. On balance, however, we believe that the market implications should be relatively contained:
• The eurozone is a more stable region than it was three years ago, when the cost of financing ten-year Greek government bonds was around 30% (December, 2011). The eurozone has come a long way since those dark days! Financing costs for the PIIGS (Portugal, Ireland, Italy, Greece and Spain) have fallen dramatically to more sustainable levels. Indeed, current yields on ten-year government debt in Ireland, Spain and Italy are below the equivalent maturity US Treasury bond (as of 7th January, 2015).
• The majority of Greek government debt (approximately two-thirds) is owned by either the European Union or the IMF. Market liabilities are therefore fairly limited.
• Greece’s fiscal and debt metrics have significantly improved. The Greek government estimates a primary budget surplus (before interest payments) of 2% of GDP in 2014, surpassing the EU and IMF target of 1.5%, and 2.9% in 2015. The Greek economy is also expected to return to growth in 2014 for the first time since 2007.
• Growth for the eurozone in aggregate is expected to be lifted this year by less fiscal austerity, supportive European Central Bank (ECB) policy, a weaker euro and, at the margin, a lower oil price.
• While the risk of Greece exiting the EMU is very real, such a scenario is not sought by Syriza (current polls indicate that 60% of Greek voters want to stay in the euro) or the sovereign heavyweights in the eurozone, namely Germany. History shows that politicians in power tend to err on the side of pragmatism over dogma.
How might Greek politics affect ECB policy?
Market expectations are high that January’s ECB policy meeting, which will be held three days before the Greeks go to the polls, will implement the long-awaited quantitative easing programme of sovereign bond purchases. The challenge for the ECB is deciding what form such a programme would take. In other words, is the ECB prepared to buy Greek sovereign debt if it felt that the Greek government could not honour it? The most widely expected outcome is that the ECB includes all countries within a QE programme, but ensures that the credit risk is assumed by the national central banks.
The eurozone – a cycle of crisis and hope
Over the last few years, the eurozone has been characterised by cycles of crisis and hope. The investment journey over the next few weeks is not likely to be a comfortable one. More often than not, though, out of a crisis we tend to see action, and the Greek election presents another opportunity for European policymakers to take measures necessary for the region’s long-term economic and fiscal sustainability.
Heartwood portfolio positioning
We continue to hold a positive view on European equities in the medium term, and we maintain an overweight position across portfolios. Relative to the US equity market, Europe is less expensive and less of a consensus overweight trade among investors. The eurozone recovery remains insipid but data is stabilising and showing some signs of improvement, including bank lending across the region and business and investor surveys in Germany. Eurozone growth expectations may have to be raised in 2015.
Our European equity position has been taken on an unhedged basis. We are not invested directly in eurozone government bonds, given the low level of yields seen generally across the continent. While the euro remains vulnerable to a strong US dollar, we expect it to remain resilient versus sterling. More generally, sterling is expected to remain under pressure on a slowing economy coupled with political noise surrounding the upcoming General Election.