The New Hidden Eurozone Risk
Complacency among investors is extremely dangerous. Many investors, both retail and institutional, have very short memory spans.
It wasn’t too long ago that the eurozone was in the midst of a financial crisis. While the worst appears to be over—at least temporarily—economic growth still remains elusive for the eurozone.
Yet in spite of all the dangers, investors have returned to the eurozone en masse. Spain recently sold one-year bills yielding just 0.994%, the lowest since 2010. Demand is extremely strong for these periphery nations, even though it’s clear that many parts of the eurozone are lacking economic growth.
Currently, Spanish 10-year bonds yield approximately 4.29%, which is down from last summer when they were yielding 7.75%. (Source: Benoit, A., et al., “Spain Sells Bill at 3-Year Low Yield as Banks Hired for Bond,” Bloomberg, May 14, 2013, accessed May 14, 2013.)
Investors are becoming complacent yet again. Instead of simply dipping their toes into the water, they’re plunging into some of the riskier parts of the eurozone that have the least potential for economic growth, and these investors are hoping that if things don’t work out, the European Central Bank (ECB) will bail them out.
The danger is that the ECB has previously stated that it will only consider short-term duration investments for possible support, not the long-term bonds. Either way, economic growth needs to re-ignite for long-term investments in the eurozone to make sense.
However, recent data from even the strongest eurozone member, Germany, indicate that a rebound in economic growth is far from certain.
According to the Center for European Economic Research (ZEW), its index of investor expectations looking out over the next six months did move slightly upward in May to 36.4 versus 36.3 in April; however, a median forecast from economists estimated that the index would move up to 40. (Source: “ZEW indicator of economic sentiment,” ZEW.de, May 14, 2013, accessed May 14 2013.)
While these data are not bad, they do not necessarily translate into strength for the entire eurozone. Even though Germany might be able to stabilize and generate some level of economic growth, I would not necessarily extrapolate this to include the entire eurozone region.
Investors are becoming complacent, as the lack of any crisis recently has allowed the water to remain calm. But beneath the surface, there is the potential for much turmoil to re-emerge within the eurozone.
The danger is that many of these investments are becoming interlinked. So a sell-off in one region could create a domino effect, causing volatility in another investment.
As long as the water is calm, the sailing is smooth. However, I would certainly suggest taking precautions and ensuring that one has a life jacket available for the inevitable storm. As I stated previously, I would certainly avoid investing in long-term fixed-income assets, as this sector is priced to perfection.