 The outcome of the Greek election was better than investors had feared. While the pro-bailout parties could have secured a more convincing majority, it appears likely that they will succeed in forming a coalition, meaning that Greece is likely to remain in the euro, at least for the time being.
The election result did not produce a significant relief rally on stock markets - perhaps unsurprisingly, as the fundamental issues, not only for Greece but also for Spain and Italy, are unchanged. Nonetheless, the news is positive for investors. The existential risk to the eurozone has receded, and there is greater optimism that the crisis can be managed from here.
Greek problems becoming more contained
Following the election, we are somewhat less concerned about the implications of Greece's debt problems for the eurozone as a whole. Greece is quickly running out of cash, tax receipts have fallen and a significant proportion of the population continues to oppose the terms of the bailout. But with a pro-bailout government in place, these issues can be managed within the context of the eurozone.
It has been obvious for a while that Greece will need additional aid. With political uncertainty receding, there is now perhaps a little more sympathy on the part of the Troika (the European Commission, the European Central Bank and the International Monetary Fund) for amending the terms of the bailout and providing further support. Greece undoubtedly faces some difficult years, but we think its troubles will become more contained.
Implications for bond markets - Nick Gartside
"As fixed income investors, we are assessing the Greek election result through two filters: politics and the economy.
Politics: "The election result was at the upper end of the scale of possible outcomes, but from a bond market perspective Greece has merely been restored to the position it was in a few months ago. The governing coalition has a fairly narrow majority, and is likely to be fragile.
Economics: "Greece is running a deficit of over 9% and the economy is expected to contract by around 5.5% in 2012. Unemployment is at around 22% and wages are forecast to fall about 5% this year. This economic position is even worse than was expected even a few quarters ago, emphasising the recent deterioration.
The outlook for Greece therefore continues to appear bleak. Nonetheless, funding costs for Greece - and for other bailout countries - may come down a little now that the election is out of the way, and loan tenors may be extended somewhat.
For bond investors, the most significant outcome of the election is that worries about whether euro membership is reversible have receded. A different result at the weekend would have opened up questions not only over Greece's membership of the euro, but over other countries too. It is important that this issue has been put to bed.
From the perspective of fixed income markets, Spain - a much larger market than Greece - is by far the most significant source of concern. Spain is suffering from three key weaknesses: its public finances (the Spanish budget deficit keeps being revised upwards), the fragility of its banking system, and sovereign debt stress. With each of these weaknesses reinforcing the others, Spain looks fragile.
More broadly, for bond investors, we expect yields on core government bond markets to remain low for a significant period. The highest conviction opportunities we are identifying at the moment are in credit, particularly investment grade credit. Corporate fundamentals are strong, and investors are being well compensated for risk by very attractive yield spreads."
Implications for equity markets - Dan Morris
"Overall, we expect moderate positive returns for equities in 2012. Equities are not extremely cheap, but valuations are well below average. Certain regions continue to offer decent prospects for earnings growth, even if GDP growth is weak. In particular, we expect the US to continue to outperform other developed markets. Fiscal and monetary policy is, broadly speaking, more stimulative in the US, at least for the time being, and the greater flexibility of the US economy also remains a positive factor, providing scope for companies to boost productivity and increase earnings per share.
"In the eurozone, Germany has been one of the better markets so far in 2012, and we are still relatively bullish. Despite the market's relative outperformance, valuations relative to other countries in the eurozone remain below average, as German corporate earnings have kept rising even as regional uncertainty has pushed prices down. In contrast with other countries in Europe, earnings forecasts in Germany are still rising.
"With respect to peripheral markets such as Spain and Italy, we believe it is still too early to go in. We do not expect to see any significant rebound in stock markets until there is greater certainty on the funding situation for these countries.
"Emerging markets have suffered this year as a result of widespread risk aversion and weaker-than-expected economic growth, not only in China but also in Brazil and India. Following this period of underperformance, the potential returns for emerging markets appear reasonably good over the remainder of the year, although much depends on the policy response. We expect Chinese growth to rebound over the course of the year, benefiting global equities and commodity exporters, but the policy outlook is less clear for Brazil and India."
Breaking the feedback loop
What will it take to convince investors that the eurozone's problems are being resolved? Consider the recent Spanish bank bailout. European finance ministers agreed to lend EUR 100 billion to the Spanish government to enable it to bail out its banks. That the markets were underwhelmed is understandable. Rather than resolving Spain's debt problems, the loan merely shifts the debt from one part of the Spanish economy to another. To break the link between indebted banks and indebted governments, the debt burden would need to be removed from the individual country and spread across the entire eurozone. If the European Stability Mechanism (the eurozone's bailout fund) was used to recapitalise banks directly, rather than to lend to governments to enable them to recapitalise their own banks, it would be extremely powerful, and would probably convince investors that the crisis was being tackled. For policymakers, however, this is a big ask.
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