By Jeff Taylor
The peoples of the eurozone really do deserve a better class of politicians than the ones they often get (mind you, much the same could probably be said on occasions for the US and UK too).
The eurozone’s handling of the current Cypriot crisis has hardly been smooth or convincing. Eurozone finance ministers initially came up with a plan to raid the savings of all bank account holders including those supposedly subject to a €100,000 deposit guarantee scheme – some press reports suggest that the ECB is unlikely to have been happy with this at all. Cyprus has ended up giving the impression of wanting to be bailed out without much sacrifice on its side, by its parliament voting down unpalatable, politically impossible proposals without a ‘plan B’.
The uncomfortably powerful economic influence of Russia over Cyprus seems to have been taken into consideration by Europe rather late in the game, leading to the unedifying spectacle, as I write, of Cypriot ministers and EC politicians now scurrying around after the event trying to patch things up. The Euro Group has given the impression of being too distant from the man in the street.
Whatever is written in this blog is likely to be immediately out of date. But it seems improbable that Germany, especially in a pre-election phase, will want to give much more ground in the structure of a bailout package: understandably, the idea of being generous to a country whose image is that of a bloated banking system and financial playground for Russian oligarchs is inappropriate and hardly a vote winner. A deal with Russia involving access to Cyprus’ large offshore gas resources has been mooted and sounds plausible, however much it recalls 19th century European power politics more than the 21st century. A default by Cyprus would be the logical outcome of an inability to make progress in all the above: hardly something that the EU would put on its Christmas list either. Cyprus exiting the euro would not necessarily have to follow a default and would impoverish its savers even more than the now apparently defunct banking levy.
None of this helps our argument for European equities deserving to be taken more seriously very short term, but let’s keep things in context at least as far as financial markets are concerned. Cyprus counts for less than 0.5% of eurozone GDP. The economic and financial knock-on effects on the rest of the eurozone are minimal: even between Cyprus and Greece, the intertwinings of the banking systems are not what they used to be. The circumstances of Cyprus – tiny economy, massive banking sector, heavy exposure to non-resident depositors, reputation, fair or otherwise, for lax regulation – are genuinely radically different to any other eurozone country, meaning that ‘contagion’ across the zone is not logical. The reaction in equity and bond markets so far has been relatively measured, though Europe being Europe, future overreactions cannot be discounted yet.
Europe’s valuation discount remains too high even with the region’s complications and occasional dalliance with dysfunctionality. The ECB said last year that it will do ‘whatever it takes’ to save the euro and we see no reason to believe that that is no longer the case. Leading economic indicators and earnings revisions, though depressed, are both stabilising. The range of attractive corporates with appealing business models in a range of sectors from financials to pharmaceuticals is as good as ever. Our valuation-driven investment strategy remains unchanged by Cyprus: overreactions are there to be exploited.
Jeff Taylor is head of European equities at Invesco Perpetual
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