- Greece’s descent into financial ignominy was completed last week as it signed-up to another EU/IMF bail-out and associated austerity package.
- A last minute agreement to get German and French banks to agree to roll-over some of their debt, in return for advantageous repayment terms, sealed the deal.
- Global equity markets, in response, enjoyed one of their most powerful rallies for two-years as investors breathed a huge sigh of relief over Greece but also had a double-whammy of better-than-expected manufacturing data from the US.
- By the end of the week equity markets were up c5% as was oil whilst gold and government bonds fell as investors switched from ‘risk-off’ to ‘risk-on’.
- But it was not all good news – the US has reached its borrowing limits whilst its politicians wrangle but no-one seriously expects it to default as the consequences are too enormous.
- The UK recovery continues to fade with a drop in consumer confidence and more failures on the High Street last week. House prices remain in the doldrums too with mortgage lending languishing according to the BoE.
- European equity manager, Stuart Mitchell, explains his current strategy and why he is optimistic looking ahead.
After dominating the financial headlines for months, last week saw another phase of Greece’s slide into financial ignominy as eurozone governments, along with the IMF, wrote out yet another bailout cheque. This one is meant to be the last, of course, but not everyone is convinced and there are those waiting in the wings, primed to say, “I told you so.” On the other side of the eurozone, Portugal is under increasing pressure, said The Financial Times, as its new government faces a struggle to meet deficit targets agreed with international creditors after the release of worse-than-expected results for the first quarter of 2011. The figures could trigger more austerity measures from the country’s prime minister, Pedro Coelho, who has pledged to do “whatever it takes” to ensure Portugal fulfils its commitments and avoids falling into a similar predicament to Greece. The centre-right coalition will have to cut the budget deficit by almost 3% of GDP by the year-end, to comply with the country’s €78bn bailout package.
Whilst many believed it was unthinkable that Greece would be allowed to default, given the ramifications, last week witnessed some last-minute, breath-holding moments. With Germany holding out for an agreement that ‘private (read ‘banks’) investors’ should bear some of the pain, a deal was not assured. However, following much behind-the-scenes activity, Germany’s largest banks and insurers agreed to participate in the bailout package, with the country’s finance minister, Wolfgang Schauble announcing that banks had agreed to roll-over €3.2bn of Greek bonds. The scheme was of French origin and quite complex in make-up: it involves investors rolling over 70% of their debt, keeping 30% in cash, with Greece receiving only 50% of the original amount and the final 20% going into a ‘Special Purpose Vehicle’ which will buy top-rated bonds as collateral. Confused? Well, many analysts were too it seems but the bottom line is that Greece will pay a coupon of 5.5% on 70% of the debt even though it only receives half the money. And the winners? “The plan is mostly designed to continue transfers from the EU taxpayers and the IMF to French and German banks and to buy some time – perhaps a year or so,” was the view of J.P. Morgan.
Markets Power Ahead
Once the Greek parliament had voted in favour of the new austerity package, the pathway to rescue was cleared, with only a signed agreement from the EU/IMF the remaining formality. This was secured over the weekend which meant that Greece would receive the €12bn it so desperately needed. In the final run-up to the deal, investors sensed victory and voted with their feet by buying equities and selling bonds and gold as ‘risk-on’ replaced the multi-week ‘risk-off’ strategy that had prevailed for many weeks. The rally had started late the previous week as confidence began to grow that a solution would be cobbled together by policymakers and it continued throughout last week. There was a brief pause midweek which coincided with the Greek vote but the upward march resumed and markets ended the week in spectacular form, with many major indices adding 5% on the week – the best performance since mid-July 2009. In London, the heavyweight blue-chip FTSE 100 Index came close to hitting 6,000 and it was a similar story on Wall Street where investors cheered with relief.
But the rally was not wholly about Greece avoiding a default. Just as weak manufacturing data from China – the country is trying to engineer a ‘soft’ landing – and also the eurozone threatened to sour the rally, the Institute for Supply Management’s index of US factory activity broke a three-month downward trend, beating market expectations. “The soft patch is over – the ISM index for June rose to 55.3 from 53.5. This was a surprise, though less so following Thursday’s strong Chicago purchasing managers’ report,” commented ING. The Financial Times thought the better-than-expected numbers would mean that the US Federal Reserve is likely to increase interest rates in mid-2012 as opposed to early 2013. As shares surged it was no surprise that investors sold down less risky assets such as government bonds and gold, which fell 2% on the week. Also, despite the US successfully selling part of its strategic oil reserves as part of the International Energy Agency (IEA) deal, oil prices rallied with Brent crude rising almost 5% on the week to $110 per barrel, effectively negating the drop following the IEA’s announcement the week before. So by the end of the week, shares and oil prices were virtually back where they were before the Greek crisis unfolded in early May.
After last week’s excitement one could be forgiven for thinking that blue skies and sunshine prevailed but there are clouds out there and potential headwinds. A failure by Congress to increase US borrowing authority (it’s currently capped at 100% of GDP – around $14 trillion) would have a “significant and unpredictable” impact on capital markets and the American economy, President Obama warned last week, adding, “The headwinds we are already experiencing will get worse.” His comments came as partisan bickering continued between the Republicans and Democrats with the latter wanting tax increases on the rich and the former spending cuts. Mr Obama is under pressure to secure a deal against the backdrop of a flagging economy in the run-up to next year’s presidential elections. Not that anyone really believes Congress will stall much longer – the implications are too serious, according to the US Treasury’s managing director. John Lipsky said he was “confident that the participants are well aware of the potential risks of a debt default in the US and will avoid those dangers”.
Despite the gigantic US stimulus package introduced in 2009 together with the US Fed printing some $2.3 trillion of ‘new’ money via its quantitative easing (QE) programme, recovery has been slower than expected. Indeed, the Fed’s second round of QE ended last week as it closed its $600bn asset purchase scheme, although its merits are not clear to all. But James Bullard, the St. Louis Federal Reserve Bank president, observed that QE had achieved its policy objectives: a rise in share prices, a weaker dollar, a decline in real interest rates and higher inflation expectations. But the flip side is that it has led to rocketing inflation in other countries, chiefly Brazil, while in the US growth has been pedestrian, house prices are still falling and unemployment remains high. The age of cheap money may also be drawing to a close if policymakers in the US and UK listen to comments from the Bank for International Settlements, which is calling for an end to “near zero” interest rates in many leading economies. Not that there’s any sign of the Bank of England changing policy – interest rates have remained unchanged for over two years and with the recovery still fragile, the markets are not expecting any change for the next eighteen months at least.
It seems that consumers’ feel-good factor is fading following the royal wedding and Mediterranean-like weather back in April. The Office for National Statistics (ONS) said that activity in Britain’s services sector, which covers everything from hotels to legal services and accounts for 75% of the economy, fell by 1.2% in April, after rising 0.8% in March. Economists are, apparently, concerned that the recent fall could start a trend, especially as it is coinciding with falling consumer confidence. Recent surveys, by GfK NOP Social Research, reveal that Britons are less optimistic about their personal finances and the state of the economy and were also less willing (or able) to save. The pain is particularly evident on the high street where, last week, two more shopping chains – TJ Hughes and Jane Norman – became the latest to teeter on the brink of collapse, potentially putting 6,000 jobs at risk. So it comes as no surprise that a survey of 30 independent economists shows that the average forecast for UK growth is just 1.5% for this year against the 1.7% expected by the Office for Budget Responsibility. Some economists are even more pessimistic, expecting growth of just 0.3% for the second quarter and for the economy to slow further in the months ahead – HSBC expects growth of only 1.2% against the 1.7% the Chancellor’s public spending plans are relying on.
With equity markets having been very volatile in recent weeks it is no surprise that private investors will have been relying upon the skills of professional investors to guide them through uncertain times. Stuart Mitchell manages European equities which have been at the epicentre of the Greek crisis. “I’ve always had the view that a Greek default would be very unlikely. Germany, as the eurozone’s largest economy and exporter, has a heavily vested interest in maintaining the longer-term stability of the region. After all, if it were not part of the euro, its currency would be some 40% or so higher which would impact severely on its competitiveness and would be untenable. Overall, I think we are halfway through a normal economic cycle with plenty of recovery still to come – not just in France and Germany, the latter whose economy grew at an annualised rate of circa 8% in the first quarter – but in the emerging economies too. Whilst I own European equities, some 15% of earnings are derived from developing economies. For example, I own Swatch, a high quality brand, where China accounts for 30% of sales and has enjoyed a 50% increase in earnings in the last year.
“The portfolio remains focused around 25, high quality stocks, with around 70% concentrated in France, Switzerland and Germany and industrials, health care, technology and consumer goods accounting for 85% overall. At the start of the year I took profits on those companies which were most economically sensitive – these have subsequently fallen more than I expected, down around 30–40% – companies such as Air France, Fiat and Pandora. In their place, I’ve added super blue-chip companies like Atlantia, Amadeus (an airline global booking company) and Banco Santander. I’d like to buy more German companies but this is difficult because many remain family-owned which has meant that I tend towards French companies where the market is more equity-based. One stock I’m very excited about is Groupe Eurotunnel which comprises about 5% of the portfolio. The business operates on circa 60% capacity with plenty of room for growth. Eurostar is growing fast and will benefit from the big increase in TGV lines that are being opened; for example, Amsterdam to Frankfurt. The company is also benefitting from a strong recovery in freight. I think it’s a unique asset, with a fixed-cost base. So overall, I shall be sticking with high quality businesses that demonstrate strong earnings growth potential and are market leaders.”