The European Union’s $116 billion bailout of Ireland’s largest banks is the latest reason to avoid exposure to the euro, as well as to sovereign debt from “peripheral Europe,” according to Chris Diaz, manager of the $525 million ING Global Bond Fund Ticker:(INGBX).
“The risk is that the troubles ultimately spread across Europe and to the rest of the global economy,” Mr. Diaz said.
The eurozone, which represents 20% of the world’s gross domestic product, “has the potential to be in a recession in the first part of next year, and that will be a significant drag on global economic growth,” he added.
The announcement of the rescue package last weekend has done little to calm the global markets, which Mr. Diaz said are viewing such bailouts merely as a way to postpone the inevitable decision to reduce debt by raising taxes and cutting spending.
“The system is built on confidence, and when confidence goes away, you end of up with contraction,” he said.
“Ultimately, [raising taxes and cutting spending] might not be a good recipe for growth, but there might not be any other choice,” he said.
Mr. Diaz, who is navigating the European debt crisis with allocations to high-quality emerging-markets securities and a full range of corporate bonds, said there are similarities to what’s happening in Europe now and what happened in the United States in 2008.
“The issues are being forced by the market,” he said.
Those market forces are most evident in the swelling yields on sovereign debt in some of the more fragile eurozone countries.
In Ireland, for example, the yield on the 10-year government bond has been pushed up to 9%, creating a record spread between the 2.6% yield on comparable German bonds.
In analyzing eurozone debt, Mr. Diaz uses Germany as the benchmark because it is the largest and most stable of the eurozone countries.
Along with Ireland, Spain’s debt is yielding 5.5%, Italy’s 4.6% and Portugal’s 6.7%. Greece’s debt is yielding 11.5%, but the country already has received a bailout.
This bond trend is not good, according to Mr. Diaz, who fears that wider spreads illustrate more risk of default, which could lead to more bailouts. “All the spreads are getting wider and they’re going in the wrong direction, and the spreads are at all-time highs,” he said.
For now, Mr. Diaz is finding safety in some higher-quality emerging markets such as Brazil, South Africa, South Korea and Mexico. “These are considered emerging markets, but they still have investment-grade ratings, lower debt-to-GDP ratios, and frankly, they’re in pretty good shape,” he said.
In addition to the emerging markets, the go-anywhere fund is also investing in both high-yield and investment-grade corporate debt.
Mr. Diaz has even been investing in low-yielding U.S. Treasuries.
“There’s not a lot of price appreciation with Treasuries, but at least you’re able to earn a coupon,” he said. “It’s a low-yielding type of world for all assets right now.”
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