Think again before investing in western Europe, says top consultant

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Warning of the likely break-up of the European common currency, Bain & Co has advised its clients to freeze new investments and manage down exposures if possible. “This is one of the few times when it will likely pay to take a step back,” it said in an unpublished note to clients seen by The Wall Street Journal.

Bain argues that the UK’s vote to leave the European Union and the growing tide of nationalism across Europe has increased the likelihood of disintegration of the 19-country eurozone bloc that uses the euro. Further destabilisation could happen quickly and may prompt investors to “rush for overcrowded exits,” it warns.

Bain issued its advice before the Italian referendum on Sunday which prompted the resignation of Prime Minister Mario Renzi and was seen by some as a victory for populists in the heart of the eurozone.

Others believe markets have overreacted to the risks to the eurozone posed by populist movements.

A survey of investors published last week by Sentix, a Frankfurt-based research group, put the chances of Italy leaving the euro in the next 12 months at 19.3%, the highest since the poll started in 2012.

In contrast to the mostly gloomy forecasts about the impact of Brexit on the UK economy, Bain says the best place for investors in western Europe to avoid “collateral damage” from a break-up of the single currency may actually be England (rather than the UK as a whole given the possibility that Scotland decides to secede).

According to Karen Harris, head of Bain’s Macro Trends Group, it is possible that Brexit negotiations take so long that major parts of the European Union leave before the UK has a chance to complete its exit.

Bain’s expectation that the single currency will break up is based on its view that the diverging inflationary pressures between key member countries are unsustainable. It also says the growing overhang from seven years of crisis is making the cost of lasting union ever more expensive.

“Fatigued governments and populations are less likely to be disposed to the sacrifices required to create durable pan-EU institutions,” it said.

Although Bain is advising clients to “withhold new investments” in Western Europe, Harris said there could be good investments to be made if they are focused on single countries, rather than cross border, or are in areas such as research and development, automation or defense.

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