Market Bulletin (14/02/2017)
In 1972 German television aired a sketch by Monty Python, in which the leading lights of Greek philosophy face off in a football match against a team of Germany’s leading thinkers. In the end, the Greeks win 1–0, even though the only goal (scored by Socrates) is technically offside.
Last week, the two countries appeared to be at loggerheads once more, and the risks are anything but philosophical. Yields (which move inversely to prices) on two-year Greek bonds rose to their highest since June last year, following a decision by the IMF to refuse to help Greece with its debt repayments, although recovered somewhat late in the week.
Germany refuses to take part in any rescue that the IMF absents itself from, which means that Greece currently lacks a plan for its July repayments. The IMF, for its part, has said it will not participate unless the EU agrees to cut the debt burden (known in bond parlance as ‘imposing haircuts’). Germany views any debt write-downs for Greece as politically ‘offside’ and will not approve them (not least because it is Greece’s largest creditor). The apparent standoff remains unresolved, despite weekend talks, but all parties hope a resolution can be found before Europe’s election season begins in March.
To add to the difficulty, the Dutch finance minister told his national parliament last week that the Netherlands wouldn’t support bailouts without IMF involvement either. Donald Trump’s nomination for EU ambassador commented this week that he expected Greece to “sever ties and do Grexit and exit the euro”, while Angela Merkel and Wolfgang Schäuble both said that Greece needed to implement reforms or leave the currency union, which would mean a return to the drachma.
Of all the various challenges facing the EU, the Greek drama may be the most likely to reach an unpleasant denouement in the near future, but it should at least be containable. The possibility of Marine Le Pen winning the French presidential election, however, while perhaps less likely, could have far graver consequences for the EU and eurozone alike.
Last week, French bond spreads (used as a gauge of perceived riskiness) widened against German Bunds to their highest level in four years. Much of this widening was due to growing expectations that the European Central Bank is preparing to gradually exit the market after an extended period of quantitative easing. Yet at least some of it appears to have been for political reasons. The leader of France’s Front National said last week that the party wished to redenominate the currency, returning France to the franc – some €1.7 trillion of French public debt (around four fifths of the total) would be redenominated, according to reports. Moody’s said it would treat such a move as a sovereign default – the largest in history. The financial tremors of redenomination would be felt worldwide.
“Having heard a few more of her plans, we are acutely aware of the downside risk of a Front National victory,” said Mark Holman of TwentyFour Asset Management. “Additionally, we have the real possibility of early elections in Italy, where the vote could be closer. We have already seen significant spread widening between both French and Italian debt relative to… German [debt]. [There have been] material losses.”
For the moment, Le Pen is not favourite to win the presidency – and her party is still less likely to win June’s legislative elections. Although she will almost certainly win the first round of the presidential vote, the odds are largely against Le Pen winning the second. Current polls show her winning around 37% of that two-candidate run-off – still some way off the margin of error, even allowing for any un-polled populist upsurge.
Oiling the wheels
Amid the jangling nerves, economic indicators for much of Continental Europe look better than they have done in some time. Figures for growth and unemployment in the eurozone have all become more positive in recent weeks – business sentiment is at its highest in six years, while job creation has hit a nine-year peak. Moreover, most of the expansion has been fuelled by domestic demand. The Eurofirst 300 rose 0.85% last week, as corporate results continued to trickle in. Total, the French energy major, reported encouraging fourth-quarter results and said that it would be raising its dividend for the first time since 2014. BNP Paribas, France’s biggest bank, announced it would be doubling its investment in digital technology to $3 billion – such news offers a fillip to business sentiment.
Economic activity in the UK has been similarly buoyant. Data released last week showed that industrial production beat expectations in December – manufacturing and construction both performed strongly.
The FTSE 100 rose 0.98%, constrained in part by the oil majors, as data showed rising crude stockpiles in the US, a trend likely to pare back recent oil price gains. In fact, both Shell and BP, the two largest listed companies in the UK (by market capitalisation), have performed well in recent months, after a tough couple of years for the sector. Bob Dudley, BP’s CEO, said last week that the company was recovering well. He added that the company would increase capital expenditure by $1 billion in the coming year. The share prices of BP and Shell have both risen by more than a third in the past twelve months.
While corporate news and economic indicators offered plenty of cheer, the UK’s Institute for Fiscal Studies offered more sobering analysis, reporting that the UK’s tax burden would rise to its highest level in 30 years despite further cuts to public sector spending. According to its central forecast, austerity looks set to continue into the 2020s. Despite forthcoming tax cuts, the net shift is towards tax increases – on dividend income, insurance premiums, pension contribution restrictions and so on. If its predictions are correct, there will be pressure on the government to remove still more tax perks before long. Investors and retirement savers alike should take advantage while they can – there are still a few weeks to use up this tax year’s allowances.
Down to business
US stocks meandered early in the week, but received a sharp boost when Donald Trump said he would soon be making a “phenomenal” US corporate tax announcement. The S&P 500 finished the week up 0.75%. Earnings season in the US has been largely upbeat, with average fourth-quarter earnings cresting above 8% year-on-year. Entertainment majors were among the stronger performers. Time Warner enjoyed a boost as HBO, its TV network, reached a US subscriber tally of two million. The Walt Disney Company also reported a strong quarter. The earnings buoyancy contrasted with Japan, where earnings season is looking far less encouraging – although the resultant weakening of the yen helped the Nikkei 225 up 2.4% last week.
As the US economy continues to normalise, so interest rate expectations are solidifying. In January, US companies refinanced $100 billion of loans, the largest monthly total in at least a decade, so as to lock in a lower rate. Nevertheless, concerns persist over Donald Trump’s trade policies, amid fears (repeated by Deutsche Bank last week) that he may label China a currency manipulator. As ever, the different faces of Trump – businessman and protectionist – appear to point to different economic outcomes.
“There is no doubt in my mind that he intends to be a pro-business president,” said Howard Marks of Oaktree Capital. “In other areas, the outlook is less clear. We are trying to be fully invested where we can, but with more caution than usual.”
Oaktree Capital and TwentyFour Asset Management are fund managers for St. James’s Place.
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