Why A Disorderly Eurozone Collapse Is Unlikely

2011 was by nearly any count a volatile year chock full of news—the majority tied to the eurozone, specifically the countries known as the PIIGS (Portugal, Italy, Ireland, Greece and Spain). While we expect 2012 to be an overall more positive year for markets, that doesn't necessarily mean PIIGS will instantaneously disappear from headlines.

However, 2012 marks the eurozone debt saga's third anniversary—and it's pretty rare any single storyline drags on markets that long. Headlines just don't usually have that much staying power. Nevertheless, many—particularly in the media—continue fretting a disorderly eurozone collapse.

Following are some reasons we at Fisher Investments think that scenario remains unlikely in the near term:

• Europe "kicking the can" on a PIIGS resolution, though perceived as negative, is likely the appropriate policy. Calls for Europe to "figure it out" create an illusion there's a magic bullet that will fix everything—but that's just not the case. At best, this is a long adjustment process requiring the trial of new measures until things stick. Moving slowly also provides other benefits—like giving markets time to gauge risks, allowing banks to bolster capital and giving the private sector a chance to find solutions outside of direct government involvement. In our view, the larger the role the private sector plays in any resolution, the better—government involvement heightens the risk officials enact regulations with unforeseen negative consequences and wind up doing more harm than good.
• A bank recapitalization plan is a positive for ring-fencing systemic risk, though it may result in bank equity dilution and deleveraging. Europe will enforce 9% core Tier 1 capital minimums to ensure investor confidence in bank capitalization. This likely reduces the risk of contagion, though banks may experience dilution of their bank equity and some deleveraging.
• Italy and Spain continue implementing austerity and improving growth prospects. Both Italy and Spain have new governments focused on drafting and passing additional austerity measures, and in our view, they need to begin shifting their focus to more pro-growth initiatives. Thus far, ECB bond purchases continue helping Spain and Italy finance their debt at affordable rates and wait on growth. But the sooner true growth and increased competitiveness come to those countries, the better.
• Easing inflation provides the ECB with more room to cut interest rates and take "extreme" action if necessary. With inflation expected to fall to the ECB's 2% target, that leaves more room for further rate cuts and balance-sheet expansion. February's three-year LTRO (long-term refinancing operation) is expected to be met with significant demand—and if it is, that would flood banks with even more liquidity.
• Short-term political backing of the euro is strong. Eurozone politicians seemingly remain dedicated to supporting the euro—as evidenced by their continued efforts to reach agreements despite significant hurdles (political and otherwise).
• Political turnover has been high, but new governments also remain committed to the euro. Italy, Spain and Greece all recently formed new governments that support the euro and have implemented additional austerity measures, regardless of those measures' popularity with constituents. France likely follows suit in its upcoming April election.

Taken together, these factors seemingly illustrate sufficient reason to believe the likelihood the eurozone suddenly and disastrously implodes remains fairly low. Granted, conditions could change, and the situation will undoubtedly continue evolving over the coming months and years. But that isn't necessarily a bad thing—and in our view, the slower and more deliberately that process takes place, the better it likely is from a global markets perspective.

This article constitutes the views, opinions, analyses and commentary of Fisher Investments as of February 2012 and should not be regarded as personal investment advice. No assurances are made Fisher Investments will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.