Johan Cruijff, the brilliant, idiosyncratic, stubborn seventies football genius once told a reporter: “Listen, if I wanted you to understand it all, I would have explained it better”. Any market observer of the past week’s macro shenanigans should have sympathy for that hapless reporter. The political and market news has been dominated by last minute wheeling and dealing in Europe and the United States, to stave off short-term crises in the guise of dealing with much longer term structural problems.
These problems may have straight forward if painful economic solutions, but they clearly do not have straight forward or easily palatable political solutions. Investors were relieved to get some good news, or at least the news that there is now a finger in the dyke, and markets rallied.
Stocks were up over the week, with the MSCI World Index up just over 2%, and bonds were down, with the US 10 year off almost 2%. Stocks rose most strongly in Europe, and particularly in Greece, Italy, Portugal and Spain, whose bonds also bucked the trend elsewhere and rallied. Equity markets worldwide were led higher by financial stocks, particularly banks, which rallied against their significant underperformance in 2011 so far. Commodities were up in dollars over the week.
The summer is proving to be a volatile, news dependent period for markets. The specific measures announced for Greece at Wednesday’s EU summit, and the extension of lower interest rates and longer maturities to Ireland and Portugal, were combined with a beefing up of the European Financial Stability Facility (and its successor ESM).
Immediate pressures were alleviated, but the end game is clearly that greater fiscal integration and structural reform to enable better economic growth are needed for the Eurozone to function effectively for all its members. The last year of sovereign crises amongst the southern members has edged the Eurozone further down this path.
The focus now switches to Washington. There’s a fairly straight forward technical problem, Congress and the Senate raising the debt ceiling. There’s a fairly intractable political problem, made worse by some highly intransigent ideologues in Congress, of finding a compromise between government spending cuts and tax increases as a means of reducing the budget deficit.
A flurry of proposed or leaked deals over the week raised market anticipation of a weekend solution, but this has not materialised and this week starts with equities and bonds down. Treasury Secretary Geithner has called today (Monday) the practical deadline for any legislation to start in the House of Representatives in time to make the August 2nd deadline.
The threat hanging over law makers is the loss of the treasured AAA credit rating for US debt, with the implication that risk premia would have to rise. Meanwhile the second quarter corporate reporting season in the States has gone well so far, with about 75% of earnings announcements and 60% of revenue announcements by S&P 500 companies beating expectations according to ISI.
Of note was Apple’s very strong quarter, with revenues up over 80% year on year, driven by a six fold increase in sales in China. Luxury goods companies in Europe also reported strong performance in China.
Global equities stand on 11.7 times forecast earnings, with a dividend yield of 2.5%. Emerging Market equities stand on 10.5 times with a 2.6% yield. The US ten year yields 3%, compared with the German ten year at 2.8% and the UK ten year gilt at 3.1%. The balance of risk and reward remains with equities.
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