Saving the Eurozone – Market Update

Today we have seen the Reserve Bank of Australia cut interest rates by 0.25% to 4.5% which is good news for those with mortgage debt and makes it a little more challenging for those with money in a bank account trying to maximise income return.

In October we saw a rebound in share markets driven by a combination of improved economic data out of the US and signs Europe is heading towards a “comprehensive” response to its sovereign debt crisis.

Saving the Eurozone

After some delay, Europe has finally announced a range of measures.  The downside with most policy is that much of the detail is yet to be worked out so it looks more like a work in progress than the final solution.  Keep in mind that this is the third attempt by Europe to get its debt problems under control so continue to watch this space as we are not out of the woods yet but things are starting to look a little better.

So what are the measure that have been agreed by the Eurozone?

  • A 50% reduction for private investors in Greek bonds.
  • A program to recapitalise banks thought to require around €106 
billion, with banks given till mid-2012 to get core capital ratios up to 9% (after writing sovereign bond holdings down to market levels), after which they have to rely on their governments or lastly the European Financial Stability Facility (EFSF) for funding.
  • A scaling up in the firepower of the remaining funds in the EFSF (of around €200 billion) to around €1 trillion, by using it to provide first loss insurance on sovereign bonds and associating it with a special purpose investment vehicle which would buy bonds issued by struggling countries such as Spain and Italy, with funding hopefully coming from non-European sovereign wealth funds, the International Monetary Fund (IMF) and private investors.

Measures ‘to further integrate fiscal policy’

The latest set of measures goes further than those before and should help to head off a near-term meltdown. Europe has accepted the reality that Greece is insolvent (with its debt to gross domestic product (GDP) ratio projected to grow to 180% of GDP next year), 
so it has moved to further reduce Greece’s debt burden and protect banks as well as other countries in the process. 
  However, just like with financial planning, having a plan is one thing, but implementation is another.

The powers that be in Europe haven’t done too well on this front over the last 18 months and it is no guarantee this will end of the European debt crisis.

Where to From Here?

We are at least starting to move in the right direction.  US economic data has picked up some pace recently, consistent with growth of around 2-2.5%.  This is not great, but is also not recession territory, which was feared a month ago.

Overall, the economist around are becoming more confident that the global recovery will continue with around 3% global growth next year, with 1% in advanced countries and 5% in the emerging world. This is sub-par but not in recession territory which is comforting.

Since early October share markets are up by around 10 – 12%.
A further bout of short-term weakness cannot be ruled out and the ride is likely to remain volatile.

There is value in the share markets (particularly in Australian shares) with grossed up franking credits, dividend yields still high at 6-7%.  For financials and blue chip stocks, dividend yields are even higher than this up to 8 -9%.  This is well above bank term deposit rates and means share values only need to rise by 3% per annum or so to provide pretty attractive returns for long term investors.

This added to the interest rate cut today to 4.5% and income producing shares with the right time frame view can be an attractive strategy for long term income needs.

US economic data has improved with solid September quarter profit results.  
Europe is far from out of the woods, but is moving to substantially reduce the risk.  After the September quarter, which is normally the weakest quarter of the year, October often marks an important turning point ahead of some strengthening into year–end. So far, it looks to be the same this year.

My advice still stands for clients to follow a goals based investment approach and ensure they have clarity around their timeframes and need for income and or growth based investment returns.

There are opportunities around at the moment but we will continue to see this volatility.

If you need assistance in exploring these further talk to a professional but most importantly start your journey to being free around your money and creating wealth with understanding.

Scott Malcolm (scott@money-mechanics.com.au) is Director of Money Mechanics (ph: 6257 5557) a fee for service advice firm who are authorised to provide financial advice through PATRON Financial Advice AFSL 307379.

The information provided on this article is of a general nature only. It has been prepared without taking into account your objectives, financial situation or needs.  Before acting on this information you should consider its appropriateness having regard to your own objectives, financial situation and needs.