IG Markets - Afternoon thoughts - Oct 21

IG Markets - Afternoon thoughts

Across Asia, regional markets have mostly turned positive after a fairly subdued open. Hopes of a solution to the European debt crisis continue to dominate trading. Sentiment was boosted late in US trade by reports that European governments discussed deploying $1.3 trillion in funds to tame the current debt issues. Reports suggest that Europe may combine the temporary and permanent rescue funds to unleash as much as EUR 940 billion to counter the crisis. The news has resulted in modest gains for Asian markets with the Hang Seng up 0.2%, Shanghai rising 0.2% and the Nikkei relatively flat.

In Australia, the ASX 200 has come off its highs and is now under water, down 5 points (-0.2%) at 4138. The materials, consumer staples and telecoms are weighing on the index. Despite early gains, we have since seen a reversal as investors position themselves ahead of the European summit. The miners have been sold off over the past few sessions tracking metals prices lower. We saw some buying interest in mining giant BHP Billiton which was up 1.3% earlier but it has since given up most of those gains. Financials are among the leaders on the back of gains for their US peers.

So will this “European solution” to be delivered in the coming days enable us to put this 18-month nightmare behind us? Probably not definitively behind us, but maybe to a degree that we can learn to live with, where we can swim without the fear of getting dragged under. That would certainly be a step in the right direction for financial markets.

As we know European leaders have been very slow to act to resolve this crisis. From a markets’ perspective, they seem to have muddled their way through the last year and a half, torn between self preservation and taking a financial hit for the betterment of the entire region. This is happening with France right now. It has the capacity to contribute to a significantly larger EFSF, but doing so could be to the detriment of its cherished AAA rating. As we have said on many occasions, a large part of the reason this crisis has never gone away is because Europe has been structurally ill-equipped to deal with it - One central bank determining monetary policy for a group of culturally and economically diverse countries each with their own fiscal regimes is a disastrous set of circumstances.

Also, while the market is both excited and sceptical about the supposed solution next week, it’s really only going to address one part of the problem. Laying and/or reinforcing the foundations of the European financial systems for the managed defaults (haircuts) we are going to see across Greece and potentially the likes of Italy and Spain, is only step one. It does little to address the future growth prospects of the region.

Presently you’ve also got a situation where all these troubled nations are imposing tough austerity measures on their citizens. But everyone knows austerity will not lead to prosperity. Slashing public service jobs where unemployment is already sky-high and raising taxes is only going to create further social anarchy as we are currently witnessing in Greece, and is hardly the recipe for the growth that’s needed to get these economies firing again. So while there may be some initial relief, assuming markets ‘buy in’ to whatever plan is forthcoming, it will probably only be a matter of time before investors start to question how we get these countries working again, because at the moment they’re well and truly broken.

www.igmarkets.com.au

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