Market Review 24 May 2011

Equity markets continued to be skittish and to lack momentum, though they were actually little changed on the week as a whole. Growth concerns were uppermost in investors’ minds. There were some disappointing economic releases in the US and it was confirmed, unsurprisingly, that Japan had fallen back into recession. There was also weaker data from Germany and some signs that China might be slowing.

China is clearly of enormous importance to many markets, whether equities, bonds or commodities. Concerns over the rate at which growth slows in China appear strongly correlated with the declines in commodity prices, and today HSBC’s unofficial preliminary manufacturing PMI for China fell to its lowest level in ten months.

Despite reserve requirements being raised last week by the Peoples’ Bank for the fifth time this year, inflation is still too high and the threat that growth will become too low is clearly changing the China risk balance. A positive sign for inflation is that PMI prices and property price rises in China are slowing, and a real debate on policy priorities, whether inflation or growth, is developing in China.

An added concern was a perceived deterioration in the European peripheral debt problems, particularly in relation to Greece. The yield on 10 year Greek government bonds rose above 16.5%. These problems have been with us for some time now and curiously, depending on general confidence, have sometimes had a pronounced negative effect on equity markets while at other times they have been almost ignored. Last week was an instance of the former. In the currency markets the euro shared in the pain, falling back to the 1.40 level against a somewhat resurgent US dollar.

Despite some commentators warning last week that Greece reneging on its debts or avoiding adopting greater fiscal discipline could trigger a crisis on the scale of – or greater than – Lehman’s in 2008, this seems fanciful. While troubling the markets on a short term basis each time potential Greek default enters the news.

The 10 year bond yield indicates that default or restructuring is already priced in to some extent, and the time that has passed since the problems became clear has allowed those banks holding Greek bonds to already provide against default.

The scale of the Greek (and even Irish and Portuguese) problem is manageable in the context of the eurozone as a whole; the only question is the nature of the political accommodation between the members. How will Germany and France trade off their absolute resolution to maintain the euro against their domestic desire to avoid bailing out Greece, say with interest free loans?

Currently, with the assistance of the IMF, there is strong EU pressure on Greece to implement harsh austerity measures. Growth concerns led to a continuing rally in major government bond markets. The yield on the 10 year treasury fell to a six month low and Bunds and gilts also rallied.

Commodities were another victim of the economic doubts – the major new listing, Glencore, fell below its issue price. For equity markets to regain upward momentum some resolution of the major issues will be required.

Issued by: Rupert Caldecott, CIO of the Global Asset Allocation Team, Dalton Strategic Partnership LLP, an investment management boutique in London founded in 2003 by the late Andrew Dalton