There are two aspects to the European debt crisis that investors need to consider, says Paul Taylor, Head of Australian Equities at Fidelity Worldwide Investment.
Mr Taylor says “the first is a crisis of confidence associated with the possible breakup of the European Union and the Euro as a currency. From an investment perspective the key issue is that whatever happens it would be a temporary dislocation. It is creating a crisis in confidence rather than creating any real and permanent negative impact on the global economy.
“For Australia, the impacts from this crisis of confidence would primarily be focused on the dislocation of European and global debt markets.
“This could potentially impact Australian corporates with higher debt levels as well as Australian banks seeking wholesale funding.
“However, currently Australian corporates have very low debt levels and Australian banks have been reducing their dependence on wholesale funding due to the very strong growth in domestic term deposits and low levels of system credit growth.
“The negative impact from such a crisis of confidence would likely be very short-term in nature and if anything would create a short-term buying opportunity,” suggests Mr Taylor, who is also Portfolio Manager of the Fidelity Australian Equities Fund.
“The second aspect is the global sovereign debt crisis, which includes the debt issues of many European countries as well as the debt of many developed countries around the world, including the United States.
“Debt levels of many developed markets are too high and need to be brought down to more manageable levels over a prolonged period. This is a real issue and not just a crisis of confidence and will likely negatively impact global economic growth over a prolonged period. Due to the global sovereign debt crisis we are likely to experience a low growth world for at least the next several years.
“Australia as a country is very well positioned for this low growth world. The Australian Federal Government has very low debt levels and is projected to move back into a slight budget surplus as early as next year. Australian interest rates are also high by global standards giving the monetary authorities, the Reserve Bank of Australia, ample ammunition to further stimulate the domestic economy should the global economy continue to falter.
“While we may be in a lower growth world for a prolonged period we do not believe that all regions, countries, sectors and companies are low growth. In fact we believe that there are some strong pockets of growth within this lower growth world. If a company can achieve growth in a low growth world we believe that it will be increasingly bid up by the market as a rare asset.
“Similarly, if a company has a high and sustainable dividend yield in a low growth world it will also be bid up by the market as a rare asset.”
Mr Taylor notes “at the moment valuations are very compressed as capital markets are very sceptical, believing that as we are in a low growth world all regions, countries, sectors and companies will be low growth.
“This is the ideal environment for individual stock selection. Markets are currently not differentiating between good and bad companies or high and low growth companies.
“The Fidelity Australia Equities Fund is investing in high quality companies with strong balance sheets and either good growth prospects or a high and sustainable dividend yield. We believe that these companies will continue to out-perform as they prove their growth and the sustainability of their dividends. Many of the top 10 positions in the fund have both a high sustainable dividend yield and good growth prospects,” he adds.
As for the outlook for Europe, Mr Taylor notes “the key concern is that if Greece does leave the European Union will the exit be orderly or disorderly? If it does exit, will the market’s focus then move to whether Portugal, Spain, Italy or Ireland will be next to leave?
“To ensure Greece stays in the eurozone requires a political decision, rather than an economic decision. The key issue creating the specific crisis within the eurozone is that it is a monetary union, but is not a fiscal union. The establishment of a fiscal union would allow subsidies to flow throughout the area from strong to weak states.”