We think a successful Irish bailout is more important to debt markets than to equity markets. In the debt markets, interest rates are climbing in the peripheral EU countries with high debt-to-GDP levels as fear of potential defaults rise. These higher rates immediately hurt the value of existing debt and increase the difficulty of rolling over maturing debts.
However, equity markets will be selectively affected, too. In an attempt to bring interest rates down, many governments have implemented austerity measures. We expect restrained government spending to hurt certain industries more than others. Banking, consumer durables and restaurants could all suffer as banks and consumers both deleverage and consumers reduce spending. However, in our opinion other industries such as exporters, healthcare and telecom services will likely see minimal impact.
While in the short term Ireland's problems may negatively affect sentiment towards all European equities, we think over time the markets will separate the wheat from the chaff.
Ultimately, Ireland is a small country and not that relevant to Europe as a whole. Even within Ireland (outside of its banks) most of its large corporations generate the majority of their revenues outside Ireland. The risk is contagion, but the already passed EU bailout arrangements can tide Ireland, as well as Greece and Portugal, over for some time. That said, if contagion continues to push up interest rates in Spain and it also moves towards default, then all bets are off. Recall that Spain is almost twice as big as the other three countries combined.
This article first appeared in Investment Week.
