Market Bulletin (13/07/2015)
A week that started on a negative note, as markets once again braced themselves for the latest chapter in the ongoing drama of negotiations between Greece and its creditors, ended much more optimistically.End in sight?
US, UK and European equity markets all gained over the week, despite registering losses in early trading. The S&P 500 index was up marginally, as cyclical stocks rallied on improved investor sentiment; technology, financials and materials all fared well as equities once again found favour. In London, it was mining stocks that led the way, with metal prices regaining some of their shine despite the tougher environment for commodities more generally in recent months, as demand from emerging markets has waned.
The standout performer was Europe. The FTSEurofirst 300 Index was up 3.6% over the week whilst, on a country-specific basis, Germany’s DAX index was up 2.9% and France’s CAC 40 gained 3.1%. Bond markets reflected the heightened optimism as traders rotated away from developed market government debt (yields on both US Treasuries and UK gilts were up slightly on the week) in favour of peripheral eurozone bonds and equities.
The reform package submitted by Athens raised hopes of a resolution to the country’s debt crisis and an expedited path to securing the much-needed bailout to get the beleaguered nation’s economy functioning again. As finance ministers met on Saturday to discuss the detail of the new proposal, markets had posted positive gains on Thursday and Friday, buoyed by what appeared to be the first few steps to an agreement.
And as the summit of EU leaders began on Sunday afternoon, the significance of what was at stake was not in doubt. Martin Schultz, president of the European Parliament, was quoted as saying, “This is really all about the European Union. If the EU is going to have any credible force, it is going to have to demonstrate it is capable of solving its own problems.”
After marathon negotiations into the early hours of Monday, it was announced that an agreement had been reached between the Greek government and its eurozone creditors.
Following almost 17 hours of talks, Donald Tusk, president of the European Council, announced that the 19 leaders of the eurozone had unanimously reached agreement. Mr Tusk said they were “all ready to go” on a new bailout programme for Greece, which could total as much as €86 billion, adding that Athens had signed up to “serious reforms”. Finance ministers will now “as a matter of urgency discuss how to help Greece meet her financial needs in the short term,” Tusk said.
The proposals must still be ratified by the Greek parliament, which convenes on Wednesday, but the initial framework between Greek Prime Minister Alexis Tsipras and eurozone creditors appears enough to have bolstered investors’ confidence. The FTSE 100 Index opened up almost 1% higher, building on gains made at the end of last week. European equities and the euro also rallied, and peripheral European sovereign bond spreads tightened as risk appetite improved.
Whilst most investors were focusing on Europe and hopes of an end to the Greek drama, there was a further twist in the tale for Chinese equity markets. A gain of 4.6% in Friday trading, and one of 5.8% the previous day, marked a notable recovery from significant losses earlier in the week. This rebound reflected the impact of the introduction of large-scale government measures aimed at addressing recent severe and sustained falls in equity markets. The Shanghai Stock Exchange Composite Index dropped by almost a third from 12 June to 8 July, which resulted in more than half the companies in the nation’s two exchanges – in Shanghai and Shenzhen – being suspended from trading.
In the very short term, it may appear that centralised efforts to address a collapse are having the desired effect. Large institutions have been engaged to buy stocks, others have been prevented from selling until the market goes back above the 4,500 level and margin lending rules have been relaxed. However, the proof of success will be judged over a period of months rather than a couple of days.
In the near term, the outcome remains uncertain. Clearly, the government is able and willing to provide additional support; but it faces the tricky balancing act of not allowing the situation to get out of control, and for a speculative bubble to develop, while trying to stabilise the market.
Allan Conway, head of emerging market equities at Schroders, believes that there are reasons to be optimistic providing investors are able to look further out. “Over the long term, we expect China to avoid a hard landing and successfully transition the economy. China is moving into an era of slower growth, and progress on reforms to achieve a more sustainable level of growth should be seen as a positive by the market.”
The week saw George Osborne deliver his seventh Budget, the first for an all-Conservative government since 1996. At the heart of the Chancellor’s speech was a drive to move the UK from being a low-wage/high-tax economy to one that promotes higher wages and lower taxes. Indeed, Mr Osborne has previously stated his desire for the UK to be the world’s most prosperous major economy by the year 2030.
Changes to the Inheritance Tax (IHT) regime, new rules for buy-to-let investors and an overhaul of personal taxation allowances (including the tax treatment of dividends) were amongst the most significant issues for individual investors. Osborne confirmed that the increase in the IHT nil-rate band would be funded by a reduction in the tax relief on pension contributions available to higher earners. However, the changes will not be introduced until April next year, providing a window of opportunity for those earning over £150,000 to bring forward pension contributions and benefit from current rates of tax relief. The reduction in the annual allowance for those earning over £210,000 will equate to £13,500 in lost tax relief.
The implications for markets will be more difficult to judge. However, UK PLC will welcome further cuts to Corporation Tax (to 18% by 2020) as the Chancellor affirmed that Britain is “open for business”. Luke Chappell of BlackRock believes this represents a positive step: “The reduction in the Corporation Tax rate further adds to the attractiveness of the UK as a place for corporates to locate.”
Yet the introduction of the new National Living Wage will provide a potential headwind to some sectors. “The new National Living Wage is likely to significantly increase labour costs for a number of industries, including retailers, pubs and restaurants and bookmakers. Those businesses with the slimmest margins are likely to be most affected,” added Chappell.
Richard Colwell of Columbia Threadneedle highlighted good news for construction and outsourcing companies. “Mr Osborne has pledged to set up a roads fund to rebuild the UK’s crumbling road network, which, according to the Chancellor, currently ranks behind that of Puerto Rico.” Hopefully though, that’s where the comparison with the beleaguered nation will end as its government is currently facing bankruptcy. There was also good news for defence companies, with a commitment to follow NATO guidance and spend 2% of national income on defence for every year of the decade.
BlackRock, Columbia Threadneedle and Schroders are fund managers for St. James’s Place.
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