Connected Economies Face European Risks
Policy + Politics

Connected Economies Face European Risks

iStockphoto/The Fiscal Times

The prospect of political risks joining economic and debt problems on the euro zone's list of worries, just as the outlook for global growth becomes uncertain, will keep investors focused firmly on safety plays in the coming week. The implications of French and Greek elections /node/60600  for the region's drive to impose fiscal austerity will be crucial, while March readings on industrial production in Spain, Germany, Italy and France will also highlight the challenges facing the region.

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China takes centre stage towards the end of the week with the release of inflation, retail and factory output numbers, as signs of a weaker U.S. economic performance and the deepening recession in Europe make Asia's strength more crucial.

The disappointing 115,000 increase in U.S. non-farm payrolls in April reported on Friday has heightenED fears the recovery in the world's biggest economy is fading, and will put speculation about the Federal Reserve's next move high on the agenda.

For global asset managers, the week's news and data should not significantly alter a view that has been dominated by moderate risk-on positions weighted towards U.S. and Asian equities and some commodities, offset by an underweight holding of European assets.

"Europe is definitely going to be an 'ex-growth' part of the world just because of the bank deleveraging going on, and that's not even bringing into play the euro crisis. But there are parts of the world that can do quite well when Europe is doing badly," Trevor Greetham, director of asset allocation at Fidelity Worldwide Investment said.

While the financial markets will likely continue to experience periodic panics whenever growth data or political developments disappoint, one region's low growth is not a big disaster if other regions can pick up the slack. "If Europe is 'ex-growth' it means for the rest of the world it can grow a little bit faster without triggering the inflation speed bump."

Europe's significance in global asset markets has also been declining. Looking at market capitalization within the MSCI All Country World Index, the European Economic and Monetary Union (EMU) index, which covers stocks in the 11 major developed markets in Europe Union, now represents just 10 percent of the total, down from a peak in 1998 of about 17 percent.

"What we're saying is that at the moment there's a problem in 10 percent of the world's stock market, should we worry about the other 90 percent?" said Greetham. Emerging markets, for example, are now 25 percent of the MSCI world equity index, which this year has risen about 10 percent.

But while its equity market may not be huge in the world economy, the euro zone's impact on areas like trade finance and as a source of revenues for other companies means its problems will remain centre stage.

An analysis by risk management consultants Aon Hewitt found that Europe accounted for about 25 percent of revenues for UK companies and just under 10 percent for U.S. corporations. "Over a third of the revenues for emerging market companies also come from the developed economies," said Colin Robertson, global head of asset allocation for Aon Hewitt.

Robertson noted that European equity markets are currently the cheapest markets on most measures and have a lot of scope to improve if reforms do take hold. "If Europe does restructure, and it does have to get growth higher than the cost of debt, equity investors will be looking for opportunities even it were to take a long time."

But for now Robertson said fear is a dominant sentiment in the markets, centered on whether euro zone bank restructuring and government spending reforms will take place.
"Investors are far from convinced. Apart from the ECB, the rest of the policymakers are not acting tremendously dynamically."