It’s not the peripheral country PIIGS (Ireland, Greece & Portugal) we need to worry most about right now as sovereign debt yields in Italy, the world’s third largest government bond market, swelled to 6.65%. The widely acknowledged line in the sand for Italian government bonds is a yield of 7%, which marks the point at which the situation is expected to move from tenuous to unsustainable. As a point of reference, yields breaching 6.5% in each of Ireland, Greece and Portugal tended to coincide fairly closely with the onset of outside involvement and talk of bailout packages.
Some economic data points have shown modest improvements of late, but primarily in developing countries. Defaults are widely expected in Greece and look to be increasingly a possibility in the case of Italian debt, but what concerns investors the most is how those defaults unfold. Will they take place in a controlled manner? Or will it be a disorderly affair that would surely trigger losses in creditor banks that would have repercussions for financial institutions all over the world?
Desperate times call for desperate measures and it seems that European officials are currently consulting investors and credit rating agencies regarding two possible ways to beef up the European Financial Stability Fund’s €440 billion in guarantees into as much as €1 trillion of spending power. The first option entails the creation of a “first loss” guarantee for bonds while the second option would require the establishment of a public/private partnership to leverage the funds via a special-purpose vehicle.
Investors remain skeptical that it’s safe to wade through these murky investment waters and this mindset will likely persist until the situation in Europe has been addressed to the satisfaction of all affected parties. We certainly cannot claim to have all the answers, but T.E. believes that there are many solid companies operating and/or headquartered in Europe that have been unduly punished throughout the turmoil. Many companies’ stock prices have fallen too far amidst debt woes, political infighting and uncertainty on a myriad of fronts. It seems that heightened volatility is here to stay, but for those investors with a long-term investment horizon the monumental intra-day price swings need not keep you awake at night. Investors prepared to stay the course should see themselves rewarded. When we cannot say, but given how erratic and wild the price movements have been, we suspect that few investors will be able to both call the inflection point and swiftly assume European equity exposure at that time.