Market Bulletin (06/07/2015)
It’s a ‘No’
After Greece became the first developed country to default on a loan from the International Monetary Fund (IMF), its people voted ‘No’ to a compromise offer from its international creditors. Greek banks are within days of running out of money, bringing the prospect of an exit from the eurozone that much nearer.
When Greece missed its June-end deadline to make a €1.5 billion repayment to the IMF, it joined the ranks of defaulters such as Peru, Sudan and Zambia. Prime Minister Alexis Tsipras made a last-minute appeal for an extension of the bailout, which was rejected by eurozone finance ministers. In Sunday’s referendum, the ‘No’ camp won 61% of the vote, even though a majority of the Greek people still want to remain in the eurozone.
The likelihood of that has receded further, however, as Greek banks face imminent collapse. They have been closed since last Monday, with capital controls in place and individual ATM withdrawals limited to €60 a day. With the European Central Bank (ECB) refusing to provide emergency funds, bankers say they are only days from running out of cash. When that happens, the Bank of Greece could lend them euros without the ECB’s permission – a potentially fatal breach of eurozone rules – or create a new currency to fund Greek banks and its economy. That would spell G-R-E-X-I-T.
It’s not over yet. This morning’s resignation of finance minister Yanis Varoufakis is evidence of that. Announcing his departure, he said that creditors had asked for this after the referendum results were known. Clearly, both sides expect negotiations to continue, and Angela Merkel and François Hollande meet later today to discuss what to do next.
The markets are well-prepared for a Greek exit from the eurozone. “Our long-standing view is that Grexit would have a minimal impact on the rest of Europe,” says Azad Zangana, senior European economist and strategist at Schroders. He points out that it represents just 1.8% of European GDP and its trade flows are relatively small. Most of its debt is held by official institutions like the ECB, which would not have to recognise any losses for some time.
The FTSEurofirst 300 Index fell 3.54% last week, its worst weekly performance since early May, and European stock markets anticipate a bumpy ride this week. The euro fell 1% against the dollar in early Asian trading today. At the time of writing, the FTSE 100 Index was down 0.65%, after initially falling 1.1% in early trading.
Back in the USA
While US markets were unsettled by the Greek impasse, they were equally focused on their domestic economy, with non-farm payroll numbers for June showing that employment continued to rise. However, traders were disappointed that the 223,000 increase was slightly below forecasts, and down from the previous month’s 254,000. The fact that average hourly earnings were unchanged caused greater disappointment and, some said, reduced the chances of a September hike in US interest rates.
Emerging markets in general are vulnerable to capital outflows following such a rate rise. Richard Iley, chief economist for Asia at BNP Paribas, says that the five most vulnerable economies of all are the PICTS – Peru, Indonesia, Columbia, Turkey and South Africa. He argues that investors are being “wildly complacent” if they think that a rate rise has been priced in, and that the Fed will move faster and further once it starts.
The will-they-won’t-they rates uncertainty combined with Greek worries to force the S&P 500 down 1.18%, its largest weekly drop since March. The index’s total return to date this year is 1%.
Chinese bubble
The Chinese stock market bubble that peaked in mid-June, when it hit a seven-year high, continued to deflate last week. By Friday, when the Shanghai Stock Exchange Composite Index dropped by 5.8%, it had fallen 29% from its peak. One of the market’s problems is the amount of borrowed money used to invest, and the increased use of margin funding. As the market falls, more margin payments are demanded. In order to pay up, investors are forced to sell into a falling market, accelerating the decline.
The Chinese authorities have been trying to arrest its plunge. At first, their efforts – including allowing the state pension fund to buy shares and softening margin rules – failed to work. Part of the reason that some Chinese investors are so reckless, buying into the riskiest stocks, is that they believe the state can and will ultimately support the market. That faith was sorely tested last week.
Over the weekend, however, the government introduced a raft of new supportive measures, including a quadrupling of the capital available to China Securities Finance, a state entity which gives margin financing to brokers. The Shanghai index clawed back 2.4% in Monday’s trading, but brokers still expect a volatile week ahead.
Budget boost
The UK economy grew faster than first thought in the first three months of this year. The Office for National Statistics revised first-quarter GDP growth figures from 0.3% to 0.4%. Growth for 2014 was revised up from 2.8% to 3%, which will be useful ammunition for Chancellor George Osborne when he gets up to deliver this week’s Budget speech.
Equally helpful is the fact that manufacturing employment rose in June for the 26th month in a row. Business investment increased 2% compared with the previous quarter and 5.7% year-on-year. Some economists are now saying that the UK could grow faster than any other G7 economy in 2015.
On Wednesday, the Chancellor should provide more detail on where his £12 billion in planned welfare cuts by 2017/18 will come from. Reductions in pensioner and child benefits have been ruled out, leaving working tax and housing benefits in the firing line. To eliminate the budget deficit by the end of this parliament, the Chancellor is relying more on reduced expenditure than on higher taxes. But new governments are notorious for getting tax rises and spending cuts in early, so there may be some surprises in store.
The government intends to recover £5 billion in a clampdown on tax avoidance. Osborne is expected to crack down on wealthy UK ‘non-doms’, possibly by increasing annual tax charges and scrapping inheritance of non-dom status. It has been reported that Inheritance Tax (IHT) on properties worth up to £1 million will finally be ended. The Conservatives promised similar measures to increase the IHT threshold seven years ago, but were prevented from delivering it by their Liberal Democrat coalition partners.
Over the weekend the Chancellor confirmed that this will be funded by a tapering of tax relief on pension contributions for those earning more than £150,000, with those earning £210,000 able to contribute just £10,000 to their pension on a tax-free basis.
In the longer term, the government may consider a proposal for a complete overhaul of pension savings tax. Michael Johnson, research fellow at the Centre for Policy Studies, has published a paper arguing for tax relief on pension pay-outs, rather than on pension contributions. A government source was reported as saying this was the “sort of thing we would want to consult on”.
Despite the positive UK economic news, June was the worst month for the FTSE 100 Index in three years. That owed much to the composition of the index and illustrated the international nature of our biggest companies. Greek anxieties contributed to the index closing 2.49% down on the week, the worst of the month. Over the month of June it fell 6.6%.
Around one third of the Footsie is made up of mining, energy and healthcare shares. These have taken a beating from the downturn in the commodities market (oil prices had their worst week since March) and the relative strength of the pound. The net effect is that, in spite of an improving UK economy, the FTSE 100 Index is down 0.7% so far this year.
Schroders is a fund manager for St. James’s Place.
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