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Wednesday, 30 May 2012 13:10

Update on Debt Crisis in Europe

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There has been increasing sharemarket volatility in recent weeks following the inconclusive election results in Greece.

What will happen next?
We believe that policymakers in Europe will be keenly aware of the lessons learnt from the financial crisis of 2008. Because of this, we do not necessarily believe that a disorderly Greek exit is a foregone conclusion.

Elections in Europe demonstrate that budget cuts or austerity will only ever be plausible so long as they have the support of the public. Voters in France, Italy and Greece have all unequivocally rejected the austerity at all costs approach so far in managing the crisis.

The French election has shifted the pendulum towards the possibility of a more lasting solution to the crisis - one that balances long-term structural reform, pro-growth policies and balanced budgets.

Greek exit not a foregone conclusion
While the last election in Greece saw voters resoundingly reject austerity, they equally rejected an exit from the Euro. A disorderly exit may be prevented by political will and the need to contain adverse outcomes for Europe and the rest of the world.

And, make no mistake, policymakers in the US and Asia will be tapping the shoulders of their European counterparts for an immediate and lasting solution. This may see Europe agreeing to fund Greece or a preplanned, orderly exit from the Euro.

What is the impact of the European crisis to the rest of the world?
The relative importance of Europe to Australia is small and declining – less than 10% of our exports go to the region. Asia is much more important and this dominance will only grow on record amounts of investment in the energy and resource sector.

The impact on China is also expected to be manageable. While Europe is China’s biggest customer for its exports, the recent slowdown in China has been driven primarily by higher interest rates to curb uncomfortably high inflation.

The US recovery is also continuing, and for Europe, Greece represents less than 3% of the European economy, implying that the crisis can be managed.

Given the potential escalation to Italy and Spain there is a common interest amongst all to put brinksmanship aside and implement a workable and lasting solution.

Interest rates and the AUD - twin support measures for Australia
If the European situation were to deteriorate Australian policymakers can rely on lower interest rates and a depreciating currency.

The RBA recently cut rates by 50 basis points, which is expected to support the non-resource economy, including retail sales and housing.

The Australian dollar will also track European concerns but the pace of depreciation has so far been much less than during the financial crisis in 2008.

The Federal Government also has scope to provide stimulus to the economy should there be a need to do so.

Things to consider
In periods of uncertainty many turn to cash or other strategies perceived to be safe. It is during these periods that investors all too often make decisions that are contrary to their long-term objectives.

While equity markets may well fall if Greece were to exit the Euro, it is important to also recognise that the global economy is still growing and global companies are making profits, paying back their debt and providing dividends to investors.

At the same time, the return on cash investments will decline on interest rate cuts. Bond markets look fully valued with yields near, or at, record lows for many developed economies.

During uncertain times long-term opportunities are most likely to emerge while equity markets remain below long-term valuations and policymakers may surprise markets, which could lead to a sharp turnaround in the price of equities.

Remember that frequent and undisciplined changes to your portfolio may lead to poor results. History has shown that missing just a few of the best months in equity markets may substantially reduce your overall return.

Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at May 2012.

Read 1319 times Last modified on Wednesday, 30 May 2012 13:10
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