Just over a month ago, investors were riding tall in the saddle and driving up the prices of risky assets on expectations of a V-shaped global economic recovery.
Stock market indices, including the S&P/ASX 200, Dow Jones Industrial Average, Germany's DAX 30 and Hong Kong's Hang Seng, have enjoyed stellar gains of over 50 per cent since rebounding from the depths of the financial crisis in March 2009.
But then the debt problems of peripheral European countries, namely Portugal, Italy, Greece and Spain - coined collectively as the PIGS - came home to roost and drove fear into markets.
Greece, with a budget deficit of 13.6 per cent of gross domestic product (GDP), was forced to seek a bailout from fellow eurozone members and the International Monetary Fund (IMF) after yields on its bonds soared to record levels.
The cash-strapped nation was given a $160 billion support package on the condition that it implements painful austerity measures to rein in its exploding debt.
Instead of joy and relief for investors and policy makers, global markets have taken a dive in past weeks as scrutiny widened to include the debt levels of Portugal, Italy and Spain.
The Dow Average plunged as much as 997 points during intraday trading on 5 May, a decline unseen since the 1987 stock market crash.
While the loss was pared back to around 300
points at the end of the session, debate is still raging over whether the drop was due to the severity of Europe's debt crisis or computer malfunctions.
Nonetheless, European leaders convened another emergency meeting on the 8 May weekend and concocted a $1.1 trillion so-called stabilisation fund to help weaker countries and fight off the "wolf-pack behaviour" of markets, as Swedish Finance Minister Anders Borg put it.
While the markets enjoyed a short-term burst right after the fund's announcement, conditions have again deteriorated and investors are tangled in a web of uncertainty.
Several European markets have sunk over 20 per cent, while the S&P/ASX 200 Index shed nearly 1000 points since hitting an interim high of 5025 in April. The Dow Average has also dropped around 10 per cent.
From debating how high markets can rally and whether equities exposure for clients needs to be boosted, financial planners and the investment community are now fearful about whether the PIGS woes are severe enough to cause another global recession.
The most urgent questions are whether the stabilisation fund is large enough to help the PIGS meet their debt payments, the euro's stability and, importantly, whether the fiscally-strong European nations actually have the will to help their weaker peers.
A lot of solutions to the PIGS' woes seem to rest on the shoulders of Germany and France, which investors see as white knights amid this crisis.
In the lead-up to Greece's rescue, the markets were nervous about whether the German and French governments would come up with loans, given fierce public and political opposition within their nations over any cross-border bailouts.
But one just has to look at some of the statistics to grasp what is at stake here.
German and French banks have combined exposure of over $1.3 trillion to the PIGS, according to data compiled by Credit Suisse.
That is massive, given the global economy and major financial institutions were on their knees after experiencing more than $2 trillion of write-downs and losses following the United States sub-prime mortgage meltdown.
"If that eurozone debt crisis had been allowed to get out of hand you would rapidly find the banks coming under enormous pressure," Credit Suisse Private Banking head of research Giles Keating says.
"They would be at risk of making losses.
"For example, if Greece had actually defaulted or restructured its debt, that would have fed through the banking system and then, of course, banks would then have had to cut loans back elsewhere and rapidly that would spill over into the global economy." This is why European governments had to act rapidly to "stem the rot", Keating says.
Currently the $1.1 trillion stabilisation package seems large enough relative to the financing needs of the weaker European sovereigns, but there are additional steps needed to be taken before the package is able to be fully implemented, he says.
"The first $87 billion of the support packages from the European governments is also done by an administrative line, but the next $640 billion will require approval of one sort or another, depending on the individual countries," he says.
"As you know, there was quite a debate notably in Germany over the support for Greece and so again there is an element of uncertainty there.
"And there is another element of uncertainty in that the loans are conditional upon the weaker countries, such as Spain and Portugal, implementing a new round of fiscal cutbacks. They have promised to do this, but again they have got to get that through their national parliaments."
Credit Suisse Private Banking expects markets to stay volatile in respect to execution risk of the stabilisation package in the coming weeks, and the bank is advising its clients to cut risk within portfolios.
"Very likely over coming days and weeks equity markets will trade a little bit higher than they have been, but we think there can also be times where they once again trade quite significantly lower," Keating says.
"And for that reason we are advising our clients to really restrict their exposure to riskier assets [and if] we do get a little bit more strength in markets to actually use that to reduce some of their exposure."
Dealer group Hillross Financial Services chief economist Brad Matthews says the stabilisation fund is a positive development for markets and increases the likelihood that Europe's debt crisis will be contained.
"Clearly authorities are trying to address contagion risk and the flow-on effect, not only to other European countries, but also a contagion effect that starts to impact on the perceived credit quality of banks that hold European debt," Matthews says.
"Our view would be that the bailout package and the stabilisation fund has reduced the risk of that contagion effect and that it won't spill over in the financial system generally.
"It's a reflection of the commitment of European authorities to make sure that not only Greece avoids default, but that other nations also do not have any immediate prospect of insolvency."
Whether the fund is big enough, or would even be used, is hard to discern, he says.
"Where we can draw confidence on is the fact that the fund is there. Whether or not they need to use it, it has reduced the likelihood that the weaker countries are going to default or experience cash-flow issues," he says.
While Credit Suisse is recommending clients cut back on shares, Hillross advisers are boosting clients' exposure to Australian equities due to recent falls in global markets.
"The markets have fallen because they have appropriately responded to a lower growth scenario in countries with debt problems," Matthews says.
"Those governments with debt levels of 80 per cent of GDP or more need to have a major contraction from economic growth in the future in order to service and repay that debt.
"There was always going to be a time in the future that economic growth in those developed economies in the Northern Hemisphere suffers because of the measures governments need to take.
"So I think you can argue there is some merit in the notion of equity markets falling due to a lowering of the immediate growth prospects in Europe. It's an adjustment to that; it's not a trigger for another sort of meltdown in the financial system."
Hillross is "reasonably confident" markets have overreacted to Europe's issues, he says.
He says the reason the Australian market has fallen more than its peers is not only due to the PIGS' debt issues, but also because of the resources super profits tax and policy tightening in China. "We would argue that the Australian market has overcorrected in the last couple of weeks. We believe local industrials are very attractive on valuations," he says.
Hillross recently recommended advisers boost clients' positions in Australian equities to overweight via its tactical asset allocation program.
"The other changes we recently announced were around currency hedging. So we had hedged 20 per cent of our international portfolio, but because the Aussie dollar has fallen we have increased that to 40 per cent," Matthews says.
Despite substantial falls in European markets, Hillross advisers will not be adding any specific European equities exposure through the tactical asset allocation program.
"Certainly at face value European stocks appear cheap. But I think there is a big question mark for the earnings prospects in Europe and we haven't seen the end of governments around Europe increasing taxes or decreasing spending," Matthews says.
"There are a lot more issues to potentially play out there. There have certainly been austerity measures put in place in Greece, but there are more countries with debt problems."
A risk that investors need to bare in mind is that while governments will likely work out their debt problems through austerity measures, it is possible they may cut spending too quickly.
"The austerity measures need to be done ideally in an environment of reasonable economic growth," Matthews said.
While Matthews is optimistic about the situation, Aviva Investors believes multiple outcomes are possible.
"Currently we think there are four possible scenarios because of the huge uncertainty in the global economic environment. And what we have done is based positions around those four scenarios," Aviva Investors investment specialist Gary Saidler says.
Saidler helps look after the $1.7 billion Aviva Investors Global Tactical Asset Allocation Fund, a daily liquidity global macro strategy.
"One of our scenarios in fact is a European contagion," he says.
"Essentially we have got this sovereign debt crisis in Europe, there is the possibility of not only default, but the possibility of the markets reacting badly not just to Greece but also the other peripheral European countries.
"This type of thing is causing serious market jitters so we have built a lot of protection in the portfolio to deal with that prospect."
The fund is heavily short the euro and also within government debt, has gone long on German bunds and shorted Italian bonds, he says.
Aviva Investors expects German bunds to benefit because of issues in Italy, often referred to as the 'sick man of Europe' due to its stagnating economy, public debt equating to 115.8 per cent of GDP and a 5.3 per cent budget deficit.
"Another trade that we have put on recently is long German bunds and short Spanish bonds. Again, that has the same rationale in that we expect Germany to outperform because of investors pricing in default risk into Italy and Spain," Saidler says.
The Global Tactical Asset Allocation Fund has also implemented a put option on the European banking sector.
"So essentially we know there is a huge amount of debt held in European banks' balance sheets, possibly not only from credit positions that they may have not fully realised their loss on, but also the huge amount of government debt that these banks have bought," Saidler says.
"If this debt problem does escalate, then these banks are going to suffer disproportionately compared to other sectors.
"Therefore if this problem gets out of hand, then the put option will actually add value and provide some portfolio protection should this sovereign debt problem escalate." He says it is arguable that Germany and France may be risking their own precious AAA credit ratings as they spend money to save the PIGS.
"But in terms of the pecking order of who is going to be hit first, it's going to be the peripheral countries such as the PIGS, so Portugal, Italy, Greece and Spain and possibly Ireland," he says.
"So that's where we sort of see the market for the time being because over the short-term investors have moved to safe-haven assets and currently they are viewing German bunds as safe haven.
"And that may change over time once markets start viewing this debt burden as Germany's problem as much as Greece's. But currently we believe this position will protect us over the short term."
While the bailout package may have calmed things down temporarily, the PIGS' debt problems may haunt markets again.
"You have got long-term debt problems here in Europe. Maybe it's only a matter time before the market realises [that] and another spike in market pessimism pushes markets down," Saidler says.
"However, with the size of the package you could see things level off for a while. We just don't know where markets are going precisely, but what we have done is built in protection should we go down the risk-aversion route."
While Aviva Investors sees contagion risk as a 20 per cent chance, there is also the chance of a broad economic recovery.
"But also we could see an upside surprise if you like, which is what we would call a recovery with a 20 per cent probability and given the huge amount of policy stimulus and interest rates still low generally, we could come out of it," Saidler says.
"Our central scenario is called fragmented world, which is 45 per cent, which essentially points to the fact that across regions it's quite fragmented in terms of economic profile.
"So we look to Asia and Australia where the economic outlook is very strong indeed, but when we look to the west we have got these banks not willing to lend, sovereign debt problems, consumers are wary spenders, the economic growth is facing huge headwinds in specifically Europe and less degree UK and less degree still US."
The group is also tipping inflation as a 15 per cent possibility.
"Because interest rates are low generally, especially huge amount of liquidity in the Asian markets, Asian markets have been keeping their currency artificially low and causing a credit bubble that's finding its way into property equity and commodities and it could cause a commodity/inflation bubble," Saidler says.
While the markets currently have their spotlight on the PIGS debt woes, farrelly's principal Tim Farrelly says sovereign debt problems extend far beyond southern Europe.
"It's worse in Japan. It's looking almost as bad in the US and UK but there isn't a loss of confidence in them, which is the problem with Greece," Farrelly says.
Farrelly, formerly a Macquarie Investment Management director, provides asset consulting services to dealer groups.
"In the US and UK you don't have that lack of confidence, but if they keep spending anything like they are going to at the moment . the US, Japan, UK and France for that matter will have debt way beyond the level which Greece has," he says.
"What's happening in Greece and Europe in general is really symptomatic of a much broader problem in the world, which is governments with too much debt and too much spending."
He says the problem is that the indebted nations won't be able to grow their way out of their debt problems.
"The fundamental economic structure is weak. You have consumers trying to de-leverage, governments having to de-leverage, corporates not really wanting to re-leverage, banks not wanting to give them the money to re-leverage even if they did," he says.
"So if everybody is trying to de-leverage at the same time, and when I say the same time I mean over the next two to eight years, it's just a recipe for slow growth. And so governments are not going to be able to grow their way out of their budget problems. "The only way out is going to be a massive round of austerity, which will mean hugely reducing government spending, some sort of increase in taxes and coming at the same time that really will again slow growth, which makes life even tougher. It's an awful situation they are in."
He says he expects a long period of slow economic growth for developed nations, but reckons Australia is better placed than its peers and forecasts that the economy may expand around 3 per cent annually.
"That gives you a sense of what kind of income streams might come out of shares and then you compare that to what you pay today and what's becoming clear today is that Australia is looking very, very cheap," he says.
"The Australian market has been marked down more than the rest of the world even though our prospects are so much better. Aussie shares are starting to look pretty good value; international shares much less so."
Despite gloomy expectations of lacklustre growth for developed nations in general, he says he is not expecting a major advanced economy to default.
"You kind of hope they can avoid that. Whether it happens I just don't know," he says.
"What I am hoping and expecting will happen is they will work out a way to muddle through, but it will be with significant pain along the way."
He also sounded a stark warning about the need for the US to get its burgeoning debt under control.
"If they don't do something their debt will be sort of 400 per cent of GDP and at 400 per cent of GDP interest rates will not be 2 per cent, they will be more like 10 per cent," he says.
"Which means 40 per cent of GDP each year will be going on paying government debt. That's just not going to happen. So somewhere along the way the bond markets are going to force the austerity measures in the US [and] Europe and the UK. They are all in the same boat.
"I don't think the world is about to end. But I just don't think it's going to be as pleasant a place as it used to be."
Schroders fixed income and multi-asset head Simon Doyle agrees broadly that concerns over sovereign debt go far beyond the PIGS.
"The globe has a debt problem and what we are seeing with Greece is just a timely example of what can happen when you have a lot of debt," Doyle says.
Doyle is portfolio manager for the Schroders Balanced Fund, which has around $645 million in funds under management.
"Globally, public sector debt to GDP is around 120 per cent. It hasn't been this high since the end of World War II," he says.
"What the world is worried about at the moment is partly how Greece and peripheral Europe get out of this problem without causing major issues. But it's also about how the UK, US and Europe extricate themselves from this. In my view the world is going to find it very difficult to grow itself out of trouble."
He says it was easier to reduce global public sector debt in the post-war era because the world economy grew strongly.
"This time around it's not obvious to me that there's a catalyst for global growth to be strong enough and that means we will need to see fiscal policy being tightened, particularly in countries like the US and the UK, and that means spending cuts and tax increases, all of which adds up to weaker growth," he says.
For investors this may mean an environment where periods of strong market rallies and sharp pullbacks are more likely to occur regularly.
"I think it's going to be very hard for risk assets to generate sustained strong returns over the next three to five years because of the tension between low interest rates and a cyclical recovery and the necessity for fiscal policy and debt levels to be brought under control," Doyle says.
That may mean a rethink as to what will generate value in portfolio, he says. "If you are going to see equities rallying and falling in a similar situation to the 1970s, to make money out of equities requires you to buy equities when they are cheap and sell them when they are expensive because you are not going to get sustained uptrends driven by market re-ratings driving returns," he says.
"An active approach to investors' asset allocation is going to be a very important driver of returns going forward."
Given market commentators see the likelihood that the PIGS will get out of the debt muck, albeit with help from neighbours, a huge amount of uncertainty remains in many aspects of the current situation.
While their governments have recently promised to slash their budget deficits through billions of dollars in spending cuts, they face mass protests and public tension on the path to austerity. Could social unrest thwart their efforts and make markets even more nervous?
Tax evasion, huge public sector employment and overly generous pensions that start from a very low age are also structural issues in some of these nations and need to be dealt with.
"In our view, the best way of repaying debt is through growth that is not stimulated by fiscal deficits. The best way to achieve growth is through international trade," Clime Asset Management chief investment officer John Abernethy says.
"Our view is that this growth can only occur after major adjustments are made to economies that have built up substantial inefficiencies.
"This process will require a generational change and the world simply does not have the time to wait to resolve the debt problem in this way."
As debate rages over whether Greece's bailout is a one-off and the stabilisation fund's size, Abernethy says a possible solution to Europe's woes is the creation of "inter-government and central bank IOUs", which will be forgiven at a later date.
"The scheme could involve all European countries providing and receiving loans through a managed bond market," he says.
"At an agreed time the bonds are cross-cancelled amongst the governments and their central banks.
"The coordinator to this scheme would be the IMF, who would agree to cancel their loans being also funded by deposits from countries around the world, including euro countries."
An interesting solution for what promises to be interesting times ahead for the PIGS, capital markets and the global economy.
