By Jeremy Gardiner, director, Investec Asset Management

There is an age-old adage that says one shouldn’t throw good money after bad. This phrase has become painfully accurate when referring to the numerous bailouts taking place across Europe. The problem with Europe is that while they share a currency, they are – unlike the US – not part of the same fiscal union. So while investors in US bonds can rely on the fact that surplus taxes from Texas will be used to fund California and New York, investors in Greek bonds have no such comfort and have to rely on the welfare of countries such as Germany for survival. 

For too long now bailouts have been about plugging the immediate capital needs of the various countries in trouble, while they in turn agree to cut spending and raise taxes by as much as they can get away with without antagonising protestors too much or destroying their economic growth. It’s a fine line, and too much austerity medicine too quickly runs the risk of pushing economies back into recession, which will result in taxes falling and austerity becoming even harder to implement. Solutions thus far have been designed to try and plug the hole without anyone having to compromise their lifestyles too much.

Sadly, however, debt is debt and adding more debt to existing debt is not going to remove debt and fix problems unless people in the affected countries significantly change their “siesta” lifestyles. The problem is that those whose behaviour most needs to change are the most reluctant to do so. 

Effectively, everyone has been in denial as to the gravity of the situation and this worries markets. While there has been much discussion about the European Debt Crisis there has been very little action and until there is clear evidence that banks are going to be recapitalised and the European Financial Stability Facility is worth trillions and not millions of euros, things are going to remain bumpy.
Denial appeared finally to make way for reality last weekend when finance ministers largely accepted that Greece is going to default. This means investors in Greek debt stand to lose between 20% and 50% of their investment. This could be just the shock that the Europeans need to finally get some action going. Up until now they have been indulging themselves in intellectual economic hypothesising while the situation got worse, and markets have finally had enough. While default will reduce Greece’s debt burden it is going to make it very difficult for them to borrow again in the future (just ask Argentina, which defaulted in 1999 and still struggles to raise capital in the open market).

China, on the other hand, is sitting on over $3 trillion of hard-earned reserves, earned as a result of exporting far more than they have been consuming. Whilst they are understandably reluctant to get involved, they may have to, as the EU is their biggest trade partner, and if the EU were to collapse and stop buying Chinese goods, the Chinese economy would suffer.

The recent downturn in markets is their way of signalling further weakness ahead. The global economy is slowing; there are significant fundamental issues that need to be resolved; interest rates are at all-time lows; central bank cash is running out, and the ability to stimulate is limited. We may well see a double-dip recession in several developed market countries going forward. At this stage, it shouldn’t be as severe as the credit crisis of 2008, however if the European economies start defaulting in quick succession, anything is possible. 

So, while the problems in the Eurozone are far from over, finally reality seems to be dawning and plans are being put in place. Let’s hope they work because a world of European countries defaulting like dominoes, followed by a European banking collapse and recession destabilising the entire global financial system, including China’s growth, is a world too scary even to contemplate. President Obama was right when he said “the Eurozone is scaring the world.” 

So what should investors be doing?

The simple answer is nothing. As we have said before, you can’t change sails during a hurricane, i.e. the time to adjust your portfolio is when markets are calm in anticipation of weather coming ahead, and not when you’re in the eye of the storm. If you wanted to lighten your equity holdings or switch out of the rand, you should have done that a while ago. Not now, after the rand has weakened. 

Tinkering with your portfolio at this time will most likely see you making emotional rather than fundamental decisions. Yes, the rand has taken a smack, as have markets; and yes, they may still both weaken further, but given that this weakness is in reaction to global events and emerging markets such as Brazil and India are being punished just as severely, our currency and market should retrace some of the losses and you run the risk of being caught on the wrong side of that. 

What you need to do is correctly identify your risk profile (sometimes a third party such as a financial adviser can do this more accurately than you can), create a portfolio appropriate to your risk profile and let it ride out any volatility markets present.