In this week’s bulletin:
- Better than expected economic data from the US and UK was, once more, overshadowed by the ongoing Eurozone sovereign debt crisis causing equity markets to give ground and end the week mostly lower.
- Greece’s announcement of a referendum on the latest bail-out package was unexpected and sent stock markets into reverse – the idea was subsequently shelved and the Greek Prime Minister narrowly won a vote of confidence. This proved short-lived too – Mr Papandreou resigned over the weekend and discussions are taking place to find a new cross-party leader pending elections.
- The G20 summit in Cannes proved a damp squib with leaders failing to agree on funding sources for the EU bail-out fund – hopes that China might contribute were also dashed. The last port of call was the IMF but here too there was opposition from the US and in its final communiqué the G20 talked of providing more solutions next February.
- One major agreement though was for Italy to informally open up its books and allow IMF officials to monitor its austerity programme – unfortunately this backfired when Prime Minister Berlusconi said the sell-off in the Italian bond markets was a “passing fashion”. Investors, fearing that IMF involvement was a precursor to a full bail-out reacted by selling off bonds, causing yields to rise to record levels.
- Despite the ongoing crisis, professional investors are reminding people that there are many high quality international businesses that are doing well and that growth in the emerging world continues to offer huge opportunities – Jupiter investment Management’s CIO John Chatfeild-Roberts gives his views.
With what can only be described as wearisome predictability, Greece and the Eurozone debt crisis managed once again to overshadow other, more encouraging news about the state of the global economy. Whilst the Eurozone crisis is undeniably serious and needs to be resolved, the talk of a ‘mild’ eurozone recession from the European Central Bank’s new president, Mario Draghi, seems at odds with the string of positive corporate results being released. Numbers from the likes of Estée Lauder were sparkling, confirming that their markets are in rude health. Here in the UK, the economy grew more strongly than expected in the third quarter with output rising by 0.5%, according to data released by the Office for National Statistics. Admittedly, growth over the last year is lower than expected and the recovery is slow but it’s not yet a recession either. Leading last quarter’s recovery was the all-important services sector, which accounts for more than three-quarters of GDP – the sector grew by 0.7% overall; but within this figure transport, storage and communications grew at a faster pace.
In the US, the latest economic data showed that the economy has picked up faster than most expected: automotive sales were up 7.5% in October and the economy grew at 2.5% in the third quarter. The housing market is beginning to show signs of a tentative recovery too, with property prices improving in Florida and bulk sales of distressed properties fetching 75 cents for each dollar of debt – compared to 30–50 cents a few months ago. True, unemployment numbers remain elevated but there was a net increase of 80,000 jobs in October which helped nudge down the jobless rate to 9%. Over in China, the economy continues to grow at a racy 9.4% this year, so the authorities continue to engineer a gentle slowdown by raising interest rates and tightening the reserve requirements for banks; but, encouragingly, economists believe growth will still be around 8% during 2012.
There were plenty of other numbers for investors to mull over last week. In the currency markets the yen spent much of the week hovering close to a record high against the dollar, despite Tokyo intervening in the markets on Monday in an effort to protect its exporters and, with it, economic growth. With growth slowing in the Eurozone, the ECB announced a small quarter-point cut in interest rates to 1.25%, which caught the markets on the hop. Stock markets gave up some of the hefty gains seen last month following the surprise announcement by the Greek Prime Minister, George Papandreou, that Greece would hold a referendum on its second bailout package, giving rise to fears that this could lead to a disorderly default by Athens. German and French equity markets suffered most as investors fretted over the likely cost to European banks should such a scenario occur.
No Cannes Do
To many economists and analysts it came as no real surprise that the much-vaunted G20 summit concluded on Friday without agreeing anything of substance. Last month Eurozone governments were tasked with coming up with a workable plan to restore confidence in the financial markets in time for last week’s summit in Cannes. This they clearly failed to do. Initially there were hopes that China, along with other sovereign investors, might invest in a special-purpose investment vehicle to be used to shore up weaker Eurozone members – but this came to nothing. The only other source of possible help might have been an increase in the International Monetary Fund’s (IMF) general resources, which could in principle be used for peripheral Eurozone countries. However, whilst some of the G20 members were happy to go down this route, others (specifically the US, which is the largest IMF shareholder) disagreed – which meant that the final communiqué only promised to look into the options by February 2012.
However one key agreement reached atCannes– albeit potentially open to misinterpretation – was the G20’s success in persuading Italy to request the IMF to monitor its austerity programme. No stranger to controversy,Italy’s prime minister, Silvio Berlusconi, announced on Friday that he had refused the offer of a loan from the IMF to his indebted country: IMF managing director Christine Lagarde denied this. Mr Berlusconi appeared to exacerbate matters when he declared that “Italydoes not feel the crisis” and that the sell-off in the country’s bond market was “a passing fashion”, adding “the restaurants are full, the planes are fully booked and the hotel resorts are fully booked as well”. Unfortunately, investors and the bond market took a different view: yields onItaly’s 10-year bonds surged to euro-era highs of 6.4%. This is the level at which Greece, Ireland and Portugal were forced into IMF–EU bailouts. Investors seemed to think that the fact that IMF staff will visit Rome every three months may be interpreted as evidence that Italy will also soon need a full IMF package of support. Indeed, the cost of Italian borrowing has risen in early trading today as fears grow over political uncertainties in Rome: the yield on Italian 10-year bonds rose from 6.37% to another euro-era high of 6.66% – more than 4% higher than similar German and UK bonds.
Greece is the Problem
So despite high hopes that Eurozone leaders had come up with a ‘grand plan’ last month, it is clear to the markets that the plan is already unravelling. The problems with Europe remain because the essential problem has not been solved: the one of Greek insolvency. One view expressed by fund manager Mark Tinker of AXA Framlington is: “What seemed to be largely missed in the discussions last week was that the 50% haircut was only being taken by the private sector; the majority of the debt is however in the public sector and as yet they see no reason why they should share the burden. Right or wrong, it leaves Greece still unable to meet its obligations. The essential issue then is that Greece remains insolvent but the proposals are treating it as a liquidity problem; whereas the real liquidity problem is in Italy and Spain and these are currently being touted as solvency problems.”
The issue of borrowing more than one can afford to repay was put into context over the weekend by Angela Merkel, the German Chancellor. “Almost all European countries have spent more over the years than they have earned. It will certainly take a decade until we are in a better position again,” she said.Germany, of course, speaks from a position as one of the world’s four largest creditors: it runs the second-largest current account surplus, after China, in both good and bad times alike. In other words, like other creditors, its economy has the capacity to supply goods and services that borrowers desire. Deficit economies are mirror images: their capacity to supply such goods falls short of their demand. This interdependent relationship was discussed by economist Martin Wolf, who noted that one country cannot keep its surplus and fail to finance others’ deficits. Yet Germany effectively controls the ECB, has the strongest credit rating and so decides how the rescue facilities will work. Germany takes the view that the crisis is the fault of bad fiscal policies and thus these must be corrected, hence the severe austerity measures being imposed on Greece et al. Mr Wolf went on to say that creditors can threaten to turn off the credit in the short run; but in the long term their surpluses depend on the willingness and ability of others to run deficits. He concluded that “It would be more sensible to admit that there has been too much borrowing by the profligate because there was too much lending by the supposedly prudent… as little Greece seems about to prove, debtors are able to inflict a great deal of damage [and] it would be a good idea to rediscover that reciprocal interest urgently”.
Today, Greek leaders are due to agree the name of a new prime minister to lead a unity government until fresh polls are held. The deal came after Prime Minister George Papandreou agreed to stand down over the weekend and, as mentioned, it followed days of upheaval caused by his decision – now revoked – to hold a referendum on the EU bailout plan to tackleGreece’s debt crisis. The names of Lucas Papademos, a former deputy president of the European Central Bank, and Finance Minister Evangelos Venizelos have been floated. Financial markets are likely to remain volatile until the outlook becomes clearer.
Keeping a Perspective
With events proving very changeable, it is important to keep a perspective and, following the news last week that Greece would hold a referendum, John Chatfeild-Roberts, chief investment officer of Jupiter Asset Management, gave his own interpretation on events and what it means for investors. “The news overnight of a potential referendum in Greece serves as a useful reminder that in this long-running Greek tragedy there can be no quick fixes and that when politicians are in charge of finding solutions, it is foolish to make assumptions about the outcome.
“Even before the announcement by the Greek president last night, it was clear the hard-fought deal announced byEurope’s leaders last week was not what the markets were looking for. While equity markets rallied initially on news of the deal, Italian bond yields told the real story: the deal would not be enough to stave off the market’s fear of contagion; not only for the so-called ‘Olive belt’ but for core European nations such as France. By Monday, the equity rally had faded away and today [Tuesday] Italian bond yields moved within a whisker of their all-time highs. I would not claim to know where this saga is heading in the short term and would question anyone who claims they do. Longer term, we believe, the endgame is either fiscal union or a smaller but stronger membership of the euro; we just cannot be sure what route the politicians will take to get there.
“For investors, nothing has changed. As the distinguished mathematician John Allen Paulos said: “Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security”. I would add that, as always in investment, patience is required and volatility always creates opportunities. It is essential we don’t get too caught up in the short-term emotion in markets but instead focus on identifying those companies that are likely to do well over the medium to long term and emerge from difficult periods such as these in stronger positions than they entered [them].
“The irony today is that while the macro picture is depressing in the developed world, there are also a lot of extremely healthy multinational corporate balance sheets to be found. Many of them are capable of paying healthy dividends that, in this environment of ultra-low interest rates and high inflation, investors could be hard-pressed to beat. Furthermore, we must remember that there is a rapidly growing middle class in the emerging markets who have a growing ability to spend. There is a good chance that when they do start to spend at western levels, we might witness a genuine de-coupling of the two-speed global economy that exists today.”