As banks in the Eurozone rush to raise capital, shedding trillions in assets to shrink their balance sheets, U.S. investors are faced with a new predicament: swoop in and grab that European debt on the cheap, or invest elsewhere.
Analysts at Morgan Stanley estimate that European financial institutions will offload and dole out about $3 trillion in assets over the next 18 months, as a way to raise the $115 billion in fresh capital the European Banking Authority is requiring them to collectively raise by June to help safeguard them in the event of a default. To do that, banks end up marking down their assets to attract potential buyers.
In the U.S., investors have already become bullish in Europe. According to the Bureau of Economic Analysis, in the third quarter of 2011 U.S. claims on Europeans rose $135 billion over the previous quarter, compared to one year earlier when claims fell $115 billion during the third quarter. The New York Times recently reported that well-to-do U.S. financial firms and corporations including Google Inc. were lapping up European debt, eyeing potential payouts.
But buyer beware! One of the nation’s foremost investors says that unless you are a hedge fund manager, you best keep your money out of European debt markets. “From an investors point of view, there are too many loose ends with European debt markets to suggest that the value that seems to be present would override some major concerns, not the least of which is that the Eurozone seems to be on the verge of a recession,” said David Joy, who helps manage nearly $600 billion in assets as chief market strategist for Ameriprise Financial.
A lack of clarity on whether and when countries including Spain, Italy, Greece, and Portugal will default, and how European Union authorities might respond, are the two other outstanding wild cards. “I’m very wary of participating in these markets at this point in time,” he told The Fiscal Times.
"The old saying that the market can remain irrational a lot longer than you can remain solvent applies here."
The risks may not faze hedge funds, although many took a sizeable hit in 2011. The Hennessee Hedge Fund Index fell 4.3 percent last year, marking the worst showing for hedge funds since 2008. And cautionary tales like that of MF Global, which went bankrupt following a bad bed on $6.3 billion of European sovereign debt, might make some funds think twice before diving into Europe.
However, many hedge funds are willing to take on the added risk. Typically, hedge funds build up enough liquidity and equity to be able to lock up clients’ money for long periods to wait out market unrest before liquidating an asset. Teams from Kohlberg Kravis Roberts, a New York-based hedge fund, have begun eying investment opportunities in Greece, Spain and Portugal, citing the recent unrest as potentially advantageous.
To ring in the New Year, Joy is counseling the vast majority of his clients—mostly retail investors—to minimize European equity exposure. Instead, he is urging them to focus more on domestic corporate and tax-exempt municipal bond debt and buys in defensive sectors of the U.S. market such as health care, utilities, consumer staples, and telecommunications, which rewarded shareholders last year and he expects will do the same this year as the U.S. economy continues to improve. “It’s prudent to focus on those companies that rewarded you last year, because at the very least, you’re buying good, healthy dividend yields… it’s a much better place to be than Europe,” Joy said.
But safe, low-risk investing isn’t necessarily the only way to make money in 2012, Joy said. Emerging markets including China, Brazil, South Korea, and Taiwan are worthy of investor attention this year, as those economies continue to loosen their monetary policies, paving the way for what Joy anticipates will be sterling economic and market performance in the second half of 2012. “This year, I’m tempted to begin nibbling at these more growth-oriented parts of the global economy,” said Joy, who rationalized that those markets have much smaller budget deficits than western countries, so have the fiscal wherewithal to offset international weakness. “I would still be overweighting defensive buys this year, but I would begin to build some positions in more economically sensitive parts of the market.”