The Greek sovereign debt crisis rumbled on

In this week’s bulletin:

  • Global financial markets were buffeted last week as a mix of good, bad and mediocre news, kept investors fretting.
  • The Greek sovereign debt crisis rumbled on with investors getting mixed messages from policymakers, as the Germans insisted there would be no debt-restructuring. The markets took matters into their own hands though, forcing up yields on Greek bonds.
  • UK inflation jumped sharply last month and intensified the arguments about the need for higher interest rates and MPC member Dale Spencer set the scene for small, incremental increase over the next two years.
  • Worries about global growth continued on news of Japan going back into recession and poor data from the US coupled with falling business confidence in Germany.
  • Excitement came though, in the form of social networking group LinkedIn’s stock market debut which saw the share price surge 173% as investors stampeded back into the technology sector, evoking comparisons with the Dotcom boom of the nineties.
  • Contrarian fund manager Andrew Green of GAM gives an insight into his latest thinking and why he sees better times ahead for his portfolio.

 

Markets Meander

There was a steady two-way pull last week – investors’ excitement over the prospects for the new technology company LinkedIn were tempered as they then fretted over the outlook for global growth and sovereign debt issues. The net outcome was that, overall, most markets ended the week little changed. The big picture remained consistent though, with the Greek debt crisis rumbling on as policymakers vacillated about the best course of action, leaving investors to become increasingly agitated as the week progressed. At the start of the week, German chancellor Angela Merkel spelt out her strong opposition to restructuring debt in any member state of the eurozone, contradicting speculation that Germany was pushing such a solution on Greece. On the day that the EU approved a €78bn rescue programme for Portugal, Ms Merkel declared any bailout before 2013 (when the new eurozone stability mechanism is in place) would be “incredibly” damaging.

However, the pressure continued to build as the week went on, with the IMF joining the fray and warning the Greek government that it will not receive its latest injection of financial aid unless it comes up with a workable plan to sell its assets. The debt-stricken country needs to prove it can raise €50bn from privatising state-owned assets by 2015 as part of its economic recovery plan. By Friday the mood had darkened somewhat, as the country’s reform plans were delayed, sparking tension in the financial markets. The euro dropped against the dollar and Greek bond yields rose to euro-era highs: ten-year bond yields hit 16.5% (compared to 3.4% for UK gilts) and, in a familiar pattern, worries resurfaced over Spain. Greece’s woes were compounded by rating agency Fitch, who hit the country with a credit downgrade of several notches. Given the huge social unrest in Greece, it is unsurprising that the Greek government is in no hurry to introduce further austerity measures being demanded by the EU and IMF; the country missed its Friday deadline for presenting a reform plan to parliament.

 

Zoom, Zoom

Not, regrettably, the UK economy but instead, inflation. Figures released on Tuesday showed that the Consumer

Price Index, the official rate of inflation, jumped by half a percentage point to 4.5% – the highest rate since September 2008. The worse-than-expected figure reversed March’s fall and rekindled speculation about interest rate increases, causing sterling to rise half a cent against the dollar. The Bank of England (BoE) has a 2% inflation target and in his open letter to the chancellor, governor Mervyn King had to explain the reasons for overshooting. Mr King said inflation would rise further before then falling back again. “Inflation is high at present because it is being pushed up by the rise in VAT, higher energy prices and import prices,” he wrote, adding “But unless continually repeated, the impetus from these factors should gradually diminish and, as it does, inflation is likely to moderate.” The recent fall in commodity prices will help but, according to analysis by Citigroup, the BoE has the worst record of any of Europe’s leading central banks for predicting inflation. One member of the MPC – inflation hawk Andrew Sentance – said inflation would remain high for a long period; a clear contradiction of Mr King’s views.

As to taking action, the MPC has been split for some while over the need for interest rates to be raised to tackle the problem of higher inflation. However, after months of speculation by the markets, it’s possible that the BoE is preparing the ground for a change in policy. In an exclusive interview with The Financial Times, the Bank’s chief economist Spencer Dale signalled that families should plan for interest rates to rise gradually over the next two years. He also gave a downbeat view on his outlook for the UK economy. “I’m not particularly happy about voting to raise interest rates and doing it for nasty reasons. I don’t take lightly the impact this could have on some families. But I think the cost to our economy as a whole – were inflation to persist for longer and our credibility start to be eroded – would be even worse,” he said. The Financial Times said that his comments marked the first time that the Bank has provided guidance to households on interest rates, helping them decide whether to sign fixed-rate interest mortgages or gamble on the Bank’s monthly rate-setting meetings. However, taking a quick raincheck of the markets, it seems that such small, incremental rises are old news: sterling remained unchanged on the week against the euro, the dollar and also the basket of currencies that make up the index.

 

Sunny Spells

Like the British weather, the economic outlook for the UK remains unsettled, with some sunny spells. As recent data has shown, hot weather and a royal wedding boosted consumer spending – up 1.1% in April, according to the ONS – but, regrettably, economists remain unconvinced that it is a lasting trend. “While welcome, we strongly doubt that the jump in retail sales is a sign that the consumer is roaring back to life,” said leading economist Howard Archer. Indeed, according to a report from the respected Ernst & Young ITEM Club, real household disposable incomes are expected to fall again this year after dropping 0.8% last year. This is apparently the first back-to-back fall in disposable income since the mid-seventies and the report concluded that finances will remain under pressure due to high inflation, weak earnings and families paying down debt. On the job front there was good and bad news. The unemployment rate edged down a notch as the number of workers with full-time and permanent jobs grew, but this could be offset by further cuts to come as 39% of employers say they are looking to prune. The private sector is struggling to fully offset the cull taking place in the public sector, said the Chartered Institute of Personnel and Development.

 

Hire Wire

So investors had to cope with a mixed week. It was not only the Greek sovereign debt crisis that brought the markets down to earth but also a string of desultory and poor economic news from around the world. Confirmation that Japan had slipped back into recession in the first quarter had limited impact outside Asia, but did highlight the potential for earthquake-related supply chain disruption to impact on the global economy. News from the US was disappointing, with poor earnings figures compounded by a further decline in housing construction and new-build permits. The latter though did reinforce the view that the chances of the US Federal Reserve tightening its monetary policy anytime soon appear remote, supported by the release of the latest minutes of its meeting. “The [Federal Open Market] Committee’s views about the economy can be described as optimistic but unenthusiastic – suggesting no rush to tighten policy,” quoted The Financial Times.

Commodities continued their recent reversal, albeit in choppy trading, with the price of gold closing down $15 per ounce even though eurozone worries weighed on investors – closely followed by silver which fell almost 4% on the week. The price of a barrel of oil edged down, leaving Brent crude at $112; some 10% down from its recent highs. The weak backdrop went some way perhaps to explaining why Glencore, the largest commodities trader, ended its first week as a public company on a downbeat note: its shares fell 1.1% from an Initial Public Offering (IPO) price of 530p to close at 524p.

The biggest non-event of the week must have been the announcement that the US had reached its official $14,300bn debt limit and had technically run out of money. The arguments in Congress look set to run on and are expected to go to the wire, with the chairman of the budget committee, Paul Ryan, saying a deal to avert default would probably only happen at the “last minute”.

And talking of wires, probably the greatest hire wire event so far this century must have been the stellar US market debut of LinkedIn, the social networking group, which evoked memories of 1990s-style dotcom euphoria, according to The Financial Times. The share price surged as much as 173% from its IPO price on the first day of trading in New York.

 

In for the Long Run

The euphoria behind LinkedIn may or may not prove to be justified and could be a fillip for the technology sector, which has been languishing for years, post the bursting of the dotcom bubble. One investor who has been quietly taking an interest in the sector is fund manager Andrew Green of GAM. His deep-value and contrarian investment philosophy leads him to seek out areas with excessively negative sentiment, but also with a catalyst for change. Last week he explained his current thinking and investment strategy.

“My search for value means I look for underperformance – by country, by sector and ultimately by individual stocks. If I find an opportunity I will take a small position, seedlings, and then watch patiently to see if my initial views are vindicated. Sometimes, though, one has to wait a very long time for ideas to come to fruition: it goes with the territory.

“Big picture, my current strategy revolves around several issues – including the fact that major debt issues remain unaddressed. I’ve avoided EU financials as their fortunes are subject to political timetables. I’ve avoided emerging markets [EM] – wrongly in the short term, but I believe there is currently substantial risk attached in the EM and commodity market themes. If you take China, where it is clear that inflation is proving harder to control, their policies could mean a harder landing is more likely than the market expects. But I have bought into Japan which I believe offers the greatest upside witnessed for many decades and I do own a number of banks there, such as Sumitomo Mitsui Financial. Japanese financial stocks are the cheapest in the world and overlooked, yet they are well financed following years of deleveraging and well able to provide capital for future growth. Within the UK, I’ve moved away from small, medium-cap stocks into larger companies which give the protection of high yield and so increased this weighting within the portfolio.

“Lastly, I have been very active within the technology, media and telecom sectors. One of my largest holdings is BT. As a company it was a most hated stock and its nadir was when management cut the dividend because this is only done as a last resort. However, it was also the catalyst to force management to take action and make sweeping changes – this is just the scenario I’m looking for. So today the portfolio has stocks which offer huge long-term value and I’m confident that the period of dull performance which is, by nature, an integral part of my approach, is coming to a close.”