Mario Draghi’s pledge to do “whatever it takes” to save the euro earned him the nickname, “Super Mario.” Photo by James Coldrey/Getty Images.
One year ago Friday, ECB chief Mario Draghi announced the central bank would do “whatever it takes to preserve the euro.” Headlines feting the anniversary are mixed—some say the currency’s continued existence and lower peripheral yields signify the ECB’s success, while others say economic weakness suggests policymakers missed the mark. In our view though, reality lies somewhere in the middle. Draghi’s proclamation and subsequent ECB policy helped shore up investor confidence in the currency union—a tailwind for stocks—but it wasn’t, and isn’t, a panacea. It simply bought time for peripheral nations to make fiscal adjustments and work through their economic difficulties. This remains a work in progress, but global stocks don’t need the eurozone to be in perfect shape for the bull market to continue.
Draghi’s pronouncement was a prelude to the Outright Monetary Transactions (OMT) program, which he introduced six weeks later. Through OMT, the ECB pledged to buy troubled nations’ short-term debt on secondary markets to help reduce borrowing costs, provided they requested aid and signed a memorandum of understanding with the ECB\EU\IMF troika. This meant Greece, Ireland and Portugal would get help when they returned to primary debt markets, and if Spain or Italy—or anyone else—asked for a bailout, they’d get help, too.
As yet, the ECB hasn’t bought a single bond through the program. But simply knowing the bank would step in let investors breathe a sigh of relief—armed with a free put option, they felt comfier owning peripheral debt and demanded less of a premium. This helped keep Spain and Italy’s borrowing costs manageable, enabling them to continue muddling through without a bailout. It likely also aided Ireland and Portugal’s initial forays back into debt markets last year, though the real test comes once they return to capital markets in full and the ECB starts buying bonds.
In short, the ECB gave bond owners—and investors globally—confidence the eurozone’s institutions and politicians would prevent the currency’s sudden disorderly collapse. It didn’t fix the underlying problems—nor could it—but it bought time for national governments to address them. And on this front, things are going ok.
Ireland is leading the pack—they had a head start as the Irish economy was already pretty competitive. The Irish have made some tough fiscal adjustments, but the private sector has started picking up the slack, the economy is growing in fits and starts, and recent Irish debt auctions have seen strong demand at favorable yields.
Greece, by contrast, is still Greece. The shaky coalition continues passing tough reform measures and the public sector has weathered huge cuts, but progress on privatization is slow, and private businesses are struggling. Still, Greek leaders have done what’s needed to keep receiving bailout aid (the EU approved its share of Greece’s next tranche Friday), giving them time to continue finding their way—and considering markets barely wiggled when Greece defaulted twice last year, investors have long since discounted Greek troubles.
Portugal has made significant headway in cutting the public sector and reforming labor markets, though fractures in the governing coalition have impeded progress in recent months. However, a recent cabinet reshuffle appears to have bought the coalition time, and Portuguese leaders are already eyeing further reforms—including corporate tax cuts, which should be unveiled in October. If passed by Parliament and approved by the troika, this would give businesses more funds to invest, which would boost growth and, by raising the denominator of the debt/GDP ratio, likely improve the nation’s fiscal standing over time.
Italy, like Portugal, has made some progress but endured political turmoil. Previous Prime Minister Mario Monti passed some labor market reforms, but the divided government that replaced him likely won’t be able to do much. They may pass incremental measures to boost growth, but deeper and more polarizing changes likely have to wait for a more stable government. In the meantime, choppy Italian economic growth wouldn’t surprise us—or many other investors.
Finally, Spain is showing signs of economic stabilization, with GDP contraction decelerating sequentially in Q1 and Q2 and its Leading Economic Index accelerating a bit. A scandal over campaign fundraising has embroiled Prime Minister Mariano Rajoy and stymied reform efforts in recent months, but he still enjoys strong support among his party and a majority in Parliament, which augurs well for continued reforms when and if the matter blows over.
For global stocks, this incremental progress is what matters. Stocks don’t need reality to be perfect. Rather, they need reality to exceed expectations. This time last year, many folks still feared the worst and didn’t expect the eurozone to be with us today. The simple fact of its survival—regardless of its many lingering issues—has been enough to lift stocks higher. And looking ahead, with expectations for the periphery’s recovery still rather dour, even modest economic improvement and reform should provide some positive surprise power.