10th June 2015
Rowan Dartington Signature’s Guy Stephens looks at the markets’ attitude towards Greek bail-out negotiations and a possible rise in interest rates in the US…
I have to confess that the equity and bond markets are feeling rather tired at the moment. Okay, the sun is shining, it is early summer and this is often one of the more lacklustre periods of market performance. However, there have been two big topics monopolising the market newswires for the last two years and it is getting very tedious.
The first is focused on when the Federal Reserve Bank will start raising interest rates and the second is whether Greece will stay within the Euro and what the eventual outcome of the negotiations will deliver. We have had some temporary distractions along the way such as the slump in the oil price and the UK General Election, but both of these have been net positives. We are still treading water in a tight trading range. It feels like we have two Swords of Damocles hanging above, suggesting an ever-present peril ahead and a chaotic situation if the authorities put a foot wrong or say the wrong thing. Markets are reluctant to fall without a new negative catalyst and hesitant to rise whilst the two big questions remain unanswered.
The more imminent threat is Greece. Clearly, the European authorities do not have a great track record at preventing market turmoil when a crisis approaches, often leaving things to the last minute and only acting when disaster appears imminent. This is exactly where we are now heading with Greece. The €300m due last Friday has been lumped with the other payments due in June like one huge debt consolidation deal and they now have to make a deposit of €1.5bn by 30th June. This brings the monetary crisis in Greece into sharp contrast as there is no remote way they can have the funds available, potentially triggering default. We somehow knew last week that an unexpected card would be played but this development only serves to reinforce the idea that the Greeks are negotiating their way through this like a game of spoof.
The negotiations following the election of the Syriza party were always likely to get down to a situation of brinkmanship and ‘who blinks first’. The Greek government cannot compromise any further as it is representing the electorate’s view and would breach the mandate on which it was elected – another election would likely follow as the people protest. The EU does not want a default or Grexit for political credibility and certainly does not want another Greek election as there is no time for this before the cashpoints close.
So, on balance, the EU is likely to blink first as it has a lot more to lose than Greece. This situation suggests a fudge, extending the maturity of the debt, waiving interest and providing the next bail-out tranche of €7.2bn to keep the economy and banks functioning. The alternative, however, is unthinkable which is why markets are sanguine on the downside but also why buyers are not pushing equities higher until clarity is provided. If we get this with staggered and conditional further bail-out funds, this will all rear its head again at the next deadline and the sword will remain in position. Incidentally, this is everything that Greece wanted and although this will be politically painful for Angela Merkel and Wolfgang Schauble, it is hard to imagine that the alternative could prevail.
Let’s now look at the US. The payroll data on Friday comfortably beat forecasts and other forward-looking indicators are suggesting a rebound in growth after the weak first quarter. Betting against economic momentum in the US, once established, is a fool’s game which would suggest that all is well despite the headwinds presented to the oil industry from the price slump. The world famous US consumer has just been given a shot in the arm and is unlikely to disappoint which suggests that all will be well.
However, this translates into an earlier rise in interest rates than hoped for, with September now the favourite, and caused volatility on Friday as markets fretted. Initially, stocks fell by 0.5% but finished down by 0.1% as bulls and bears jostled. Of more note was the move in bond markets where treasury yields ended the week at their highest level since last October and their largest one week gain since June 2013. This would suggest that a rate rise is now seriously on the cards and, until that happens, markets will fret about how much investors will react, which is probably not much, but will be enough to maintain the other Sword of Damocles until then.
We continue to run with moderately elevated cash positions in this environment, as we have done so ahead of the UK election and as the Greek farce unfolded. We are waiting for an entry point to exploit volatility which is highly likely. Mario Draghi added some fuel to the fire last Wednesday by saying we should get used to bond market volatility. This contradicts his long standing statement that he would do whatever it takes to preserve the Euro, the interpretation of which had been extended to mean that he will keep bond markets sanguine with quantitative easing. This latest statement casts doubt on this, suggesting that the era of centralised control over bond markets is drawing to a close, and we all know that current yields are not sustainable or consistent with a recovering economic scenario.
Bonds are off our buying list and have been for many months as we look for an attractive entry point into other asset classes, including equities. The S&P 500 is 4.3% off the top and the FTSE-100 is 4.2% below its peak but risk assets may get cheaper yet. Equities continue to easily look like the most attractive asset with economic growth providing certainty of earnings and dividends. Valuations are a little on the expensive side but earnings are on the up. If one considers how unattractive lower risk assets are, if the swords are removed, they could arguably support higher valuation levels as the perils are removed.
Eventually, the investor psyche will shift to seeing a rate rise as a good thing to restrain a booming economy and that will require some inflation to appear. Maybe this mind set will appear as the oil price falls drop out of the statistics in July and onwards to the year end? Either way, a move from the Fed sooner rather than later will spark the beginning of the end of this fear. Remember, fortune favours the brave (and patient).