30 november 2011
By Jim Cielinski, Head of Fixed Income

Financial markets have always had a fixation with short-term news flow. Indeed, the endless stream of headlines about the eurozone crisis in recent weeks has been deafening, leading markets to gyrate between panic and euphoria, often in the same day. Each month seems to bring the same question – are we nearing a “grand solution” that will finally stem the rot?

There can be no doubt that the current crisis represents a transformational event in economic history. Undue concentration on daily developments, however, can leave investors blind to the longer-term opportunities and threats. The legacy of this crisis will be felt for decades, irrespective of upcoming policy responses. Policymakers can influence the depth and duration of the pain that will be inflicted, as well as dictate how the burden will be shared by different groups. They cannot, however, make the pain go away.

Investors must realise that the rules have changed, and that they have changed for good. Some key take-aways include:

1. Growth will be slow for a very long time. Many developed economies are simply not competitive and structural impediments will preclude a rapid recovery;

2. Weaker economies need to leave the euro or accept a lower standard of living. The poor will get poorer;

3. Slow growth and high leverage will lead to periodic recession fears. The accompanying volatility will present a need for more pro-active asset allocation;

4. The European Central Bank will ultimately need to adopt reflationary tactics; these periods may be good for risky assets even as growth remains subdued. Currency is one of the few remaining policy tools and currency volatility will continue on its upward march;

5. Short-term interest rates are going nowhere fast , and so the search for income will strengthen;

6. Negative real interest rates do not equate to low risk – there are no risk-free assets remaining.