Market Review 21 June 2011

There were modest declines in equity markets and gains in bonds as the same concerns persisted into the seventh week since global equity markets peaked. After big daily swings mid-week, a sharp rally on Friday afternoon left the S&P 500 flat on the week, and Germany and France both gained. However Japan, other Asian and Emerging equity markets were off. US 10 year treasuries now yield 2.9%, and oil fell back to $93.

Two topics, Greece and global economic growth, have dominated the headlines and the short-term attention of markets. Both have increased market fear at the expense of greed, and shortened investors’ time horizons while increasing the value of certainty over uncertainty.

The saga of Greek debt continued to unfold as both farce and tragedy. Events will gather pace over the next few days. The main event will be the vote of no confidence in the Greek parliament on Tuesday. If, seems likely, Papandreou’s government survives then their domestically unpopular fiscal and privatisation legislation should be passed on Thursday the following week.

Given the supportive comments of Chancellor Merkel and President Sarkozy, the release of the final tranche of last year’s funding package and the agreement of a new package should proceed at the next Eurogroup meeting of finance ministers on July 11th. At which the issue of private sector involvement in the new funding package will arise again.

This should be in time to meet the redemption of EUR6.5bn Greek treasury bills due in July and August and a EUR6.6bn five year bond due for redemption on August 20th. Judging by the behaviour of markets following the mid-2010 crisis of confidence, investors will look favourably on a postponement of any final resolution of the Greek problem until some unspecified future date. The prospects of it disappearing quietly off the radar must be limited however. Vocal domestic opposition to the effects of the austerity package are unlikely to subside.

While the latest news on Greece drew headlines, markets were also processing continuing patchy economic data releases. The week opened with China once again hiking its reserve rate, with Chinese headline CPI for May slowing to 0.4% month on month. Declining oil prices are likely to produce weaker inflation numbers for June.

Brent crude was down $5 on the week. However weaker inflation is being taken by investors as part of a bigger picture of anaemic growth. After the poor US jobless and payroll data at the beginning of the month, the Philly Fed and Michigan sentiment surveys came in weaker than expected on Friday.

Markets have paid more attention to the top down signs of weakness, coupled with the completion of the US Federal Reserve’s “QE2” stimulus package by the end of June, than the continuing bottom up story of strong profit margins and surging company profits. Data from Factset Estimates show earnings per share were up 40% in the last reported year for the MSCI All Countries World Index, and brokers’ analysts forecast growth of nearly 19% in the coming year and 15% the year after.

It is possible that companies are not yet seeing, and communicating, the major global slowdown that the top down behaviour of markets is suggesting and these forecast earnings will largely disappear in the coming six months. However it appears more likely that the currently reported economic softness is having an exaggerated impact on equity market prices, partly fuelled by uncertainty over Greece.

Equity markets may go even lower from here if Greece takes a further step towards chaos this week. But some of the bad economic news is likely to abate, such as food and energy price effects beginning to disappear from inflation data, and if corporate profits hold up then the second half of the year should see some positive momentum in equity markets at the expense of bonds.

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