Commentary: Girlfriend in a Coma
“Do you really think
She’ll pull through?
Do you really think
She’ll pull through?
Girlfriend in a coma, I know
I know – it’s serious”
Girlfriend In A Coma – The Smiths
This week the euro zone saga plugs ahead, choppy wave after choppy wave. Last week saw the seventeenth euro summit since the Greek crisis first hit markets two years ago. It’s salutary to remember, when considering whether it is safe to have politicians and technocrats “solving” these problems, that the ECB actually raised interest rates last February. The latest summit itself was somewhat overshadowed by Greece’s continuing battle with its creditors to determine how painful its debt write-down will be as it transitions from independent over-indebted inefficiency to dependent over-indebted inefficiency.
The latest humiliation to emerge was a proposed euro zone commissioner to agree or veto Greek (and implicitly Portuguese, Irish – even Spanish or Italian – budgets). Twenty five European nations (the UK and Czech Republic stood aside) agreed to approve the new fiscal treaty promoted by Germany, and at least a half step towards the inevitable that a common currency needs a common fiscal policy to survive. It’s hard to believe that this will be the final compact to govern the common currency, locking in competitiveness for German exporters and perpetual austerity for the southern states.
At least while the future shape of the currency union is being negotiated there is now a greater sense of policy urgency, with Mario Draghi at the ECB, the LTRO underwriting bank liquidity and a clear trajectory of lower interest rates. The gloom about Europe dampened market returns in the last two days of January before February was greeted with three consecutive days of healthy equity market gains. Over the week the DAX was up 3.9%, the CAC 40 was up 3.3%, the FTSE 100 was up 2.9% and the S&P 500 was up 2.2%. Government bonds eased off, as did Japanese equities.
The United States continued to deliver positive economic news and there were both a large M&A deal (Glencore were flushed out to propose a merger with Xstrata) and a mega IPO (Facebook filing to raise $5bn or more at a valuation of $100bn). The week ended on Friday with a positive US payroll employment report of 243,000 new jobs in January and upward revisions of prior months data, with the unemployment rate lower at 8.3%. There was further data out of China with the January non manufacturing PMI down to 52.9 from 56 in December, but the Chinese New Year hit activity at month end and the picture still seems to be a slow down in Chinese growth rather than a hard landing.
In most parts of the world policy remains stimulative, and policy makers still fear deflation more than they fear inflation. In the developed world real interest rates are negative in the UK and US, and are being lowered now in Europe. The emerging markets have been easing rates in the face of clearly slowing activity for a while, with China starting to shift to more stimulation as signs of slowing activity continue to emerge.
The investment outlook continues to be messy with short run trends likely to emerge before they bounce off stubborn structural levels of both valuation and activity. Financial market risk assets have rallied so far this year, and current equity valuations don’t appear to be a barrier to further gains nor a support against further declines. With the biggest shift coming in European liquidity (declining rates, LTRO) the potential is there for significant upside in European equities, with the continuing unquantifiable risk of Greek default as the cap on broad rallies.
Elsewhere investor behaviour signals continuing uncertainty about what lies ahead. With increasingly stimulatory monetary policy and early indications of growth there is a recipe for inflationary conditions that should suit gold and commodities and property, and whilst gold has been strong over the past twelve months it ended 2011 weakly. The behaviour of yields on longer dated government bonds – ex southern Europe – suggests that for investors the perceived credit safety and certainty of yield currently trumps any fear of inflation and further growth surprises. Just a year ago investors were still betting on strong gains in developed and emerging equity markets.
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