Market Commentary: 18 July 2011
A Hell(enic) of a difficult situation
Watching the Greek debt crisis unfold is a little like being in an accident, where time seems to slow down and the outcome seems inevitable and painful.
It's a near impossibility that Greece won't default on its debt obligations at some point in the next 2 years. The most likely outcome is a ‘restructuring' of some kind - to allow a deferment of interest payment to creditors. The European Central Bank (ECB) is essentially playing for time. Their hope, which is no doubt shared by the International Monetary Fund (IMF) and other central banks, is that bailing out Greece now, gives other Southern Eurozone countries (and Ireland) time to sort out their own parlous financial situation and, importantly, European banks time to put measures in place to ensure there is limited contagion of bad Greek debt through the wider banking system. They may pull it off. Economic growth is a rosy 3.5% in Germany1 and remains robust in other parts of Northern Europe.
The longer term future of the Euro and indeed the wider European project still hangs in the balance. Until the Eurozone crisis is resolved, or at least put off for another 12 months, it is very difficult to see stock markets gaining any sort of upward traction. The FTSE 100 Index has been trading in the 5500 to 6000 range since the final quarter of last year. However, away from sectors like UK focused retailers, many stocks are trading on attractive valuations, with strong balance sheets. Having made it through the financial turmoil of 2008 companies are now in a position to benefit from what, in many instances, is an increased market share resulting from the disappearance of their weaker competitors. Our view of equities is still broadly positive.
Another reason for our favorable view of equities is our concern over certain other asset classes. Chief amongst these is an overall negative view of fixed interest assets like government bonds. In the current uncertainty the attractiveness of ‘safe haven' assets like UK Gilts and US Treasury stocks is undeniable; however, we would view these as short term only. In an era of higher inflation, low yielding assets (at near record prices) are very unattractive - particularly if you were to have concerns about the United States' long term plans to service its own mounting deficit.
Elsewhere, slower economic growth in emerging markets has forced a retrenchment of most commodity prices. Energy related commodities have been an exception. We think that slower (as opposed to slow) economic growth and lower commodities will ultimately be good for emerging market equities and so now could be a time to revisit the asset class - though patience (as always) may be required. In the meantime, Russia seems to be in the sweet spot between high oil prices (which it benefits from) and a re-rating of emerging market equities.
Finally, it's worth returning to the Euro crisis. Despite some alarming similarities between now and the financial crisis following Lehmans collapse there are important differences. The most significant is that policy makers, central bankers and financial institutions are working together to look through books and balance sheets to ascertain what bad debt is held where. The outcome is that we don't see anywhere near the same level of fear and uncertainty that prevailed in 2008. This combined with the absence of excessive hedge fund leverage should see markets avoid a wholesale sell-off. Of course it's also interesting to note the lack of shrill remarks about irresponsible lending and rampant Anglo-Saxon capitalism emanating out of Paris and Frankfurt!
James Davies, Investment Research Manager
1. Annualised Gross Domestic Product (GDP) latest data - June 2011