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Why markets can still avoid a Greek tragedy

Market View with Tom Elliott

7 November 2011

Global markets are on a rollercoaster ride, falling and rising with each new twist in the eurozone debt drama. Against this backdrop our global strategist, Tom Elliott, takes a wider view of events and explains why, despite the risks, he believes investors can currently take advantage of some attractive long-term investment opportunities.

While Europe dithers, don’t lose sight of the wider picture

The European debt crisis is the main focus for investors at the moment and rightly so. The shockwaves from any major sovereign debt default in the eurozone would be truly disastrous and would surely add considerably to the pressure on an already weak global economy. High unemployment, deflation and widespread social unrest may follow.

The risks of such an outcome have risen recently, thanks in large part to Greek political instability and the inability of a weak Italian government to implement vital economic reforms. However, I ultimately believe the euro will survive this crisis and therefore I do not believe we will see a major sustained fall in global stock markets similar to the one experienced in late 2008 following the collapse of Lehman Brothers.

There are two main reasons for this cautious optimism:

1. Europe can resolve its debt crisis

Germany and France have the financial strength to solve the current debt crisis that is undermining investor confidence. They also have the determination to make the single currency succeed and are now inching towards an understanding of what mechanisms need to be put in place to enable the transfers of money from creditor to debtor countries. This may end up with full fiscal union.

Therefore Europe is still in control of its own destiny and I believe Europe’s political leadership will eventually find a way to placate markets and restore stability to all euro members.

2. Share prices may reflect an overly pessimistic outlook

Share prices have fallen significantly from their highs earlier in the year on fears over the outlook for global economic growth. However, the picture may not be as bad as investors feared. While dithering European policymakers and recalcitrant Greek politicians have dominated the headlines in recent weeks, better economic news from the US and China has slipped unnoticed under the radar of most investors.

In China, the data points to a modest slowdown rather than a severe contraction in growth, with any bad debt problem at the bank level being absorbed by the government. Meanwhile, recent better-than-expected data from the US may pave the way for a period of stronger US growth. This all suggests that there may actually be better economic times around the corner, supported by continued strong growth in the world's number two economy and the potential for a growth surprise in the world's number one.

Beware of the risks

Although my glass is definitely half full regarding the global economy and the eurozone crisis, there are some major risks lurking in the background that investors need to be aware of. In particular, the big worry is “Japanisation”, in which the western developed world undergoes a prolonged period of low or no growth.

At the heart of this scenario is the recognition that repaying the huge sums of debt taken on by governments and households in the US and Europe will continue to impact negatively on consumer demand and therefore significantly constrain industrial output for many years. This would be a world of deflation and economic contraction. The risk is that a demand shock, perhaps from a sovereign default in the eurozone, tips the balance towards this scenario.

There is also a risk that a renewed credit crunch will exacerbate the situation, as European banks, fearful of their exposure to weak eurozone sovereign debt and under pressure from a tough regulatory crackdown, shrink their assets by reducing lending to consumers and businesses.

I am hopeful that easy monetary policies by global central banks (ultra low interest rates, quantitative easing, liquidity injections) will help the developed world avoid such an outcome. An end to the eurozone uncertainty would also help lift sentiment and take some of the pressure off the banks. But investors should keep a watchful eye on the data nonetheless.

Investment options in the current environment

Assuming Europe avoids catastrophe and the global economy avoids a damaging double-dip recession, investors can currently take advantage of some attractive long-term opportunities on global stock and bond markets.

Dividend-paying stocks

In a world of very low bank account cash rates and measly government bond yields, investors who require an income have little alternative but to invest in the shares of high dividend-paying companies. Since the initial stock market falls in early August the major developed markets have found support at certain levels because investors have few options other than dividend paying shares if they want an income stream.

Investors can take advantage of this trend towards dividends by selecting funds that invest in high-yielding blue-chip companies in the major western stock markets. Many of these companies are well managed and financially sound, but are looking much more attractively valued following recent stock market falls. Many also have dividend yields well in excess of bank deposits.

Therefore, investing in dividend strategies, such as equity income funds, could be a good choice in the current environment. You should, however, always remember that past performance is no guide to the future and the value of investments, and any income from them, may go down as well as up.

Emerging market bonds and high yield bonds

Emerging market government bonds and global high yield corporate bonds also provide UK investors with a high income yield, which is attractive in a world of low interest rates and provides some protection against inflation. Valuations are also looking attractive for long-term investors following recent weakness.

You should, of course, always make sure you fully understand the risks involved before investing. Emerging markets do carry greater political and economic risks than developed markets as they are less mature, while high yield bonds are more liable to default, particularly if the economic environment deteriorates.

Investors who are comfortable with the risks involved, and who have a long-term investment horizon, can capitalise on these opportunities through emerging market bond funds and high yield bond funds, or through strategic bond funds that actively allocate between different bond markets depending on the economic backdrop.

Read more about our latest views on the market

Please be aware that this material provides general information only and has been produced for information purposes only. It is based on information believed to be reliable at the time of writing but is subject to change without notice and we do not guarantee its accuracy. The opinions and views expressed here are those held by J.P. Morgan Asset Management at the time of publication. JPMorgan Asset Management Marketing Limited accepts no legal responsibility or liability for any matter or opinion expressed in this material. The value of investments and the income from them can fall as well as rise and investors may not get back the full amount invested. JPMorgan Asset Management Limited is authorised and regulated in the UK by the Financial Services Authority. Registered in England No: 288553. Registered address: 125 London Wall, London EC2Y 5AJ.