Fund managers view the next round of elections in Greece, scheduled for 17 June, as a "referendum" on Greece and the eurozone, with many expecting a Greek exit from the single currency to follow it.
While the consensus view is that Greece will inevitably exit the eurozone, there is division on whether this will be accomplished in an orderly or disorderly manner. Fears of contagion abound, as a Greek exit will mean outright losses for the remaining eurozone members along with a rapid erosion of confidence.
Fund managers concede that, while there will be "considerable short-term pain", an exit of the euro could provide peripheral countries with a better opportunity of long-term growth and might even strengthen the euro as it would increasingly come to reflect the German economy.
Thomas Becket, chief investment office of Psigma Investment Management, says: "We do not expect an imminent collapse in the euro, although the chances of the euro staying in the same shape for much longer are now somewhat lower. We expect Greece to finally give up and leave the austerity arrangement they signed up to, which would ultimately mean leaving the eurozone."
Mike Turner, head of global strategy & asset allocation at Aberdeen Asset Management, says: "There is no roadmap on how exactly Greece would exit, but it might be in the face of default, leading to a reintroduction of the drachma. This would be devastating for European banks, Greece's biggest creditors, who would then take a haircut on their holdings. Capital flight is already occurring from Greek and other European banks and capital controls are a very likely consequence. In extremis, a wholesale nationalisation of major parts of the banking system may be the only route to preserving financial stability."
But fund managers don't dispute that the crisis of confidence generated by the problems in the eurozone will have a global impact on both incomes and job creation, and the UK will not be immune.
With the short-term outlook for European equities extremely uncertain, European fund managers' portfolio construction has become highly stock-specific. Caught between crashing European equity markets and overpriced defensive stocks, managers have nowhere left to go, and many have raised cash from operating levels to between 5 per cent and 10 per cent of total portfolio assets, and even higher where permissible.
The UK is increasingly viewed a safe haven (not being Europe) and the pound has strengthened against the euro. With UK gilt, US treasuries and German bund yields at near all-time lows, fund managers believe government bond markets have already begun to price in the risks of a Greek exit. With the flood of capital leaving the peripheral nations, fund managers predict that some will inevitably end up in London property, which will further bolster house prices in the capital.
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