GLOBAL MARKETS WEEKAHEAD-Losing faith in the euro zone?

By Jeremy Gaunt, European Investment Correspondent

LONDON, April 30 (BestGrowthStock) – Whatever ultimately happens in
the Greek debt crisis, investors are having to come to grips
with an unstable euro zone they had not bargained for.

A knife-edge British election, a European Central Bank
meeting and monthly U.S. jobs data would all be expected to
dominate markets in more normal times. But it is the fate of
Europe’s peripheral economies that still eclipses all else.

Markets are in what AXA Investment Managers calls “panic
mode”, resulting in the European bond market being drained of
liquidity and with some investors forced to sell because of
sovereign debt downgrades.

And longer-term, the landscape has been changed by the
crisis.

Germany’s reluctance to take on its traditional role as
European Union paymaster and its willingness to let the
International Monetary Fund get involved has, at the very least,
thrown some doubt at the once-solid political foundation of
monetary union.

The struggle of Greece and others such as Portugal, Spain
and Ireland to manage mountains of debt has lit up a core
weakness of multiple countries sharing a currency — the
inability to devalue yourself out of trouble.

It has left millions of people in Europe facing not the
wealth that they expected from adopting the euro, but a period
of potentially breathtaking austerity they are ill-prepared for.

Little wonder, then, that investors have been voting with
their feet against holding euro zone paper.

Reuters asset allocation polls show holdings of euro zone
debt at 38.4 percent of bond portfolios at the end of April,
compared with more than 42 percent in January. [ASSET/WRAP]

Although the Reuters polls found little change in holdings
of euro zone equities, fund tracker EPFR Global says non-UK
European equity funds have had 12 straight weeks of net outflows
for year-to-date redemptions of more than $8 billion.

The euro itself has fallen nearly 7 percent against the
dollar this year as the crisis has built.

“People are avoiding Europe and its currency,” said Michael
Arone, who develops investment vehicles for clients with nearly
$2 trillion under management at State Street Global Advisors.

Over the short term, this could well continue.

The euro failed to hold initial gains on Monday made after
European countries agreed to a 110-billion euro aid package for
Greece at the weekend, on concerns about the plan and fiscal
problems in the euro zone.

SHAKEN FAITH

There is also a longer-term issue of whether investors will
ever look again at the euro zone in the same light.

Johan Jooste, fixed income and currency portfolio strategist
at Merrill Lynch Wealth Management, says a number of his private
clients have been questioning the sustainability of monetary
union as a result of the crisis.

Other analysts have joked that troubled debt such as
Greece’s would be a good buy as long as you do not intend to
hold on to it until maturity.

“I wouldn’t go so far as to say we concur, but the view on
the street is that this has been a pretty bad example of how to
manage a single currency zone,” Jooste said.

“This is the (euro zone’s) first real stress test and the
system has been exposed in many ways.”

That exposure, at the very least, could cause a permanent
re-rating of euro zone debt, driving investors to demand more
risk return from peripheral euro zone economies and building
demand for the core, notably Germany.

As for equities, while an unstable euro zone might not have
an immediate, direct impact on European companies’ earnings, it
can prompt investors to look around for alternatives.

“Our preference for the U.S. among the world’s developed
markets is in some respects enhanced, on a relative basis, by
the events in Greece and elsewhere,”, said David Joy, chief
market strategist at RiverSource Investments.

STEPPING BACK

All this has put most other issues in the background, even
if they are hugely important.

The ECB will almost certainly leave interest rates unchanged
at its meeting on Thursday. But it should also give some
indication of the state of the euro zone economy, incorporating
the Greek problem.

On Monday the Bank suspended its minimum credit rating
threshold on Greek sovereign debt, allowing the country to carry
on participating in ECB lending operations even if rating
agencies downgrade it further.

Britain’s general election on Thursday could see pressure on
sterling if it produces no clear winner, currently the
prediction, potentially leaving a government without the clout
to enact tough fiscal measures required to curb the UK’s own
ballooning deficit.

The U.S. non-farm payrolls report on Friday — generally the
markets’ No.1 economic indicator — will also be seen as a gauge
of how far the U.S. economic recovery has filtered down.
All three come as investors have been giving various
signals that the more than year-long equity rally is ready to
pause or correct.

MSCI’s all-country world index (.MIWD00000PUS: ) hit a more
than one-year high in mid-April but has not come close to
testing that level since.

State Street, meanwhile, reported that its monthly index of
institutional investor confidence fell back to levels last seen
in March 2009 when the stocks market slump was hitting bottom.

Reuters asset polls had a similar finding, with allocations
to stocks among 48 leading investment houses falling to their
lowest level of the year.

But it will be Greece, Portugal and the others that seem set
to get the lion’s share of attention.

Stock Market Trading

(Additional reporting by Claire Milhench and Jennifer Ablan,
editing by Mike Peacock, John Stonestreet)
(Follow investment tweets on Twitter @reutersJeremyG and/or
economics @macroscope)

GLOBAL MARKETS WEEKAHEAD-Losing faith in the euro zone?