After a strong start to the year, the global equity markets have fallen in the second half of January and the beginning of February. Some correction was expected in view of the head-spinning growth since the bottom of the market was reached in March 09; with only a few sell-offs along the way, the latest caused by Dubai’s debt repayment problems in December 09. However, with the fall in global equities approaching 10% since mid-January, combined with sharp falls in commodity prices and an increase in volatility, some stock market investors are getting nervous. 

The latest sell-off started with worries about Greece’s ability to repay, or even service, its debt. After this trigger, however, investors’ attention turned to other European countries with big budget deficits - Spain, Portugal and Ireland. Collectively these four members of the Euro-zone are referred to, somewhat unkindly, as ‘PIGS’.

Some commentators have expressed a view that we are now entering a second wave of the financial crises - the first was about the solvency of banks; the second about the solvency of sovereign countries.

It would be wrong, however, to tar all these countries with the same brush. Greece is an exceptional case in the Euro-zone. The country already had a high level of public debt long before the financial crisis, and ran persistent budget deficits during the boom years. Greece has a huge problem of corruption with the shadow, or non-taxpaying, part of the economy estimated at 30% of GDP. Furthermore, the country’s credibility was damaged after a new government recently revealed that the state of the public finances was much worse than had been previously reported by its predecessor. 

Such revelations create uncertainty, which is strongly disliked by investors. Consequently, the tough austerity measures announced by the Greek government in January failed to calm the markets, with investors continuing to demand a higher return on the country’s government debt.

Last week at a summit of European leaders in Brussels, a vague political deal was agreed pledging support for Greece in return for even tougher austerity measures. This week more details are expected to emerge from a meeting of European finance ministers.

In the medium term the markets are concerned about the uncertainty surrounding government policy. On the one hand, there are risks that a premature withdrawal of stimulus measures in the Euro-zone and other developed markets strangles the recovery before it had a chance to gain momentum, as was the case in the US in 1937 and in Japan in 1997, resulting in the ‘lost decade’.

On the other hand, investors are concerned about the sustainability of government borrowing. Bond markets are worried about the lack of a credible medium-term plan for balancing government finances. Radical reforms are required. One example of such reforms could be an increase in retirement age, which could provide substantial savings later on down the line, without negatively affecting today’s consumer demand.

Over the longer term, a clear pattern is emerging. Big emerging economies, such as Brazil, India and China, which have low levels of debt and increasing demand, seem well-placed to power global growth; while the developed economies are likely to experience much slower rates of growth than those they have been accustomed to, as both governments and consumers repay their debts.

What does all this mean for private investors? No one knows how individual asset classes will perform in the short term, so diversification and the use of alternative assets seems like a good idea. What is clear, however, is that with interest rates likely to remain at very low levels for some time, investors are being encouraged to take some risk.

If you would like to discuss these or any other market-related issues, please contact Michael Ageev on 020 8445 7886.