Calling All Contrarians
It’s hard to believe that all these months later we are still staring into the void waiting for Merkel and Sarkozy to deliver a package aimed at saving the eurozone. We’ve been told that there will definitely be a solution in three weeks. Rather unsurprisingly we’ve been given no indication as to what that might be. What is clear is that we need to draw a convincing line under fears surrounding the feasibility of European fiscal union once and for all.
In today’s Financial Times, British Prime Minister David Cameron lists the need for at least three key steps. Firstly, leaders must deliver a clear path for the resolution of Greece’s sovereign debt problem with a heavy focus on the need to cut the country’s debt levels via a significant hair-cut to privately held bonds. Secondly, there is a critical need to prevent further contagion to the larger sovereigns (particularly Italy) as soon as possible. The EFSF needs to be leveraged up to trillions of euro to ensure that the market is confident that the back stop for financing exists – the alternative is that the ECB will have to continue buying Italian bonds. Thirdly, there is an imminent need to prevent a collapse within the European banking system. This rests on the market’s faith in the stability of Europe’s financial institutions, which can be fostered through credible stress tests and the defence of bank balance sheets from sovereign default.
The sentiment in the markets suggests that we are getting close to the final roll of the dice for the Eurozone, with short interest in company shares giving indications of extreme negativity in the markets. On past performance we have every right to be sceptical that Merkel and Sarkozy can deliver on their promises. For starters, their need to satisfy political demands at home has severely impaired their ability to put a credible solution on the table. While there has been much focus on the lack of a solution, the biggest question remains whether or not the members of the Eurozone will be able to enact whatever package is presented, even if something credible is put on the table.
If the solution levelled involves amendments that leverage the crisis as an opportunity to tackle a national interest wish list – for instance, a demand to increase Irish corporate tax rates – there would clearly be a potentially catastrophic stand-off. There is a myriad of issues that could raise their head for Ireland alone. Add in the self-interest of each of the member states across Europe and we have a frightening array of potential stumbling blocks for an ill-conceived plan. Angela Merkel has already suggested that amendments to the Lisbon treaty may be required. This is doubtless a terrifying prospect for Enda Kenny considering Ireland’s previous experience, and the fact that any treaty would now face a far more eurosceptic voting population.
In light of Europe’s fractious past and, the political challenges that any solution will face within individual sovereign nations, let’s hope that the package delivered in three weeks time is not only substantial but has been structured to ensure that its swift roll-out can be implemented. A shock and awe rescue package would stem the negative feedback loop that has allowed this crisis to evolve into the monster that it is today. It may be scant consolation but many of the most successful investors in the world have made their fortunes by taking contrarian investment decisions. If you believe the contrarian doctrine, the inference from all of the negative sentiment is that we are set for a large rally in the financial markets. Let’s hope that Europe’s leaders can guide us back from the edge and that the contrarian’s are right once again.