Market Commentary - July 2015
Writing this before the Greek Parliament opines on the less than generous offer from the Troikanauts, we cannot be certain about the outcome, but it won't be good for Greece either way. If the Greeks vote to stay inside the euro camp and take their medicine the symptoms of pain will go away…temporarily… as the root cause of the issue has not been addressed. The eurozone’s problem is the euro. Without total (totalitarian?) political union it’s a dead duck and, one by one, the existing members will come to that conclusion, but not before a lot more pain and anguish has been heaped upon those who are least capable of dealing with it.
A “no” to austerity, but a mandate to stay within the eurozone won’t work either, unless the existing creditors, mainly the ECB and the IMF, agree to debt forgiveness. Even then continuing euro membership will just start the whole rotten process over again. How important is Greece to the rest of Europe? In truth not very (less than 2% of GDP), but if they are not kept in the fold the rumblings in Spain, Italy and France will gain in volume and the Troikanauts will have a serious problem. We are going through a period of market volatility, in both bonds and equities that we have not seen for some time and keeping some powder dry continues to make much sense. If there is a serious dislocation in Greece then there will no doubt be short-term opportunities to buy into Europe, but remember that the threat of contagion will then be higher. If the Greeks fold then nothing has changed and probably as early as the autumn, when the next large tranches of outstanding debt become due, we will have to go through the same process again, but under a new government that may be more acquiescent; the dénouement will inevitably be the same.
As in May bond markets have been flat over the month, but not without periods of volatility. Equity markets have in the main trended downwards as the uncertainties surrounding Greece and the euro and the interest rate regime in the US, have been a concern. European equity markets have perhaps surprisingly performed better than expected; even the Athens index is pretty much flat for the month. The Chinese bubble that we flagged up last month has at last burst, the Shanghai A shares index down nearly 30% in under three weeks. We continue to use less than our full risk budget in our endeavours, yet our model portfolios have held up very well over the past 12 months. We still believe that valuations in both equities and bonds are, in the most part very rich, and we increased our defensive positions last month. There will be opportunities to move back into unloved sectors and we will have sufficient ammunition when that time comes.
The election is behind us, summer has arrived and the sell in May pundits are sporting large grins. On the 8th the chancellor gave us his second budget within 4 months. As ever, the devil was in the detail. The FTSE has fallen over 6% since the May peak. Hardly the stuff of bear markets but with the UK economy allegedly the strongest in the G7 it is not going in the expected direction. Mid and small caps also had a rest in May but they were looking somewhat over extended and in fact still do.
The lack of momentum we highlighted last month continues and the S&P 500 is back close to the 200 day moving average, which has provided much support in the past. The market is still technically in an uptrend and a close below 2000 is needed to encourage the bears into action.
In bond world the suggestion by the Greeks that the loans they have been given are immoral and illegal and should be written off has been taken up in Puerto Rico. Puerto Rico is a “commonwealth” state of the US and as such could be classified as a rather large municipality. We have had a number of significant “munis” in the States proper file for bankruptcy – Detroit for one - and the Puerto Ricans want to do the same. Rather like the fact that there is no mechanism for leaving the euro the Puerto Ricans cannot file for bankruptcy, but something needs to give, adding another $75billion to the haircut party.
Much is made of the improving economic backdrop in Europe, but it is still an anaemic affair and helped in the main by a weak euro that keeps the export engine going. Ex Greece there is undoubtedly some value in the bourses; a stock-pickers market, not one for the passive brigade.
The Nikkei came within an ace of our long-standing 21,000 target last month and sterling is closing in on Y200 so it looks like time to take some money off the table here. The Chinese currency is looking precariously over valued and if the People's Bank of China are looking to help Chinese exporters then as a corollary Japanese imports will be that much more expensive.
Asia Pacific and Emerging Markets
The main story here is the fall in the Chinese markets, which according to the Guardian has wiped £2 trillion off share values. The “authorities” seemed unaware on the way up that this sort of correction could happen and are now faced with managing the fall out in a similar manner. The Chinese love to gamble and the massive increase in margin account openings is a testament to that. Maybe the government is trying to send a message that capitalist ways are not all they are cracked up to be. If so they have succeeded rather spectacularly! A market to leave alone for the time being. The rest of Asia and emerging world have lagged world markets taken as a whole but not by a great extent. The green line on the Asia Pacific chart is the World index and the picture in Emerging Markets is the same.
Commodities and gold
Last month we said of oil and copper that, the global economy is still fragile overall so perhaps more sideways than up is the best we can anticipate.” And that is pretty much what has happened. If there were some real fire in the global economy this index would not be in a downtrend. Since 2013 there has been a disconnect between the World equity index and the commodity complex. Either equities are too expensive or commodities are too cheap. A bit of both perhaps?
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Value is almost impossible to find and the other major concern in these markets is liquidity. In the sovereign debt markets, volatility is frightening off even the biggest players. Ironically the Basle banking regulations, which have set the capital requirement for holding “very secure” sovereign debt at 0%, allowing some significant gearing into these markets, may well turn out to be the catalyst for the next crisis; the law of unintended consequences always strikes where it is least welcome. Who would have thought that over 30 years you could have made as much in bonds as in equities?
The central banks, as ever, hold the key to market movements. The ECB has gone all in with a €1 trillion QE programme stretching out until September 2016 and a US rate rise seems as far away as ever although an unexpected earlier move would be unsettling to say the least.
• Government bonds still look expensive despite the ongoing bond “rout”. The long-term trend in yields is beginning to turn up.
• Spreads on corporate bonds are still tight. They are not cheap either and default risk can only rise from here, making high yield potentially less attractive. Is the yield premium adequate? There is also significant concern over liquidity risk.
• Western equity markets are still expensive and momentum does seem to be waning as we wait for the next round of GDP numbers to offer evidence of the trend in global growth.
• Property remains attractive as a real asset offering a higher spread against most fixed interest markets, but not without risk.
• European markets are in a state of flux. ECB QE should be beneficial for financial assets and will remain so until the Greek issue is resolved; a fudge will be a temporary band aid. The Nikkei index has reached our initial target at 21,000. Emerging and Asia Pacific markets are not overly expensive, but will continue to be volatile and negatively affected by dollar strength.
• Central banks are committed to negative real yields; the ECB, the SNB and the Danish central bank have all gone for negative nominal rates! Ultra loose monetary policy will create inflation eventually, but currently deflation is still an issue and it is getting harder to see where anything other than tepid growth is going to come from.
• Gold and gold mining shares are still in a bottoming out phase as long as support around $1,200 holds.
Clive Hale, Director - July 2015
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