Commentary: Quit Ye Like Men
Two (and – after a short trip to Holland – a bit) weeks into May finds the weakness of April has continued for risk assets. Volatility has returned and may well – at best – be the order of the day for the rest of the summer. Global equities (MSCI ACWI) are down 5% in sterling, with the emerging markets down nearly 8% led by the “BRICs” all being down over 8%, with Brazil off 11%.
Given that the eurozone and the Greek and French elections have dominated the headlines one might have assumed that Europe and financials would be the reddest numbers of all, but MSCI Europe ex-UK is down 6.5% month to date compared with MSCI USA down 3.2%, and financials are down 6% but materials and energy are both off more around 9%. Risk has returned with a vengeance, and certainly peripheral European bond and equity markets have suffered, but the principal losers have been the growth engines of the world.
Within global equity markets the trends that were evident in March and April have accelerated in the first two weeks of May and stocks that we define in the categories of “Defensive”, “Defensive Quality” and “Quality Growth” have produced very strong performance relative to their “Cyclical” peers, replicating the pattern of last summer. The major government bonds have rallied sharply as well, with the US 10 year now yielding just less than 1.8%, the 10 year Gilt yielding 1.9% and the Bund yielding 1.5%. By contrast the Spanish 10 year has jumped to yield 6.3%.
The failure of the Greek election to produce a government has refocused investor attention on the parlous state of the eurozone. It is uncertainty that spooks investors, so that even though the potential exit of Greece from the eurozone is apparently a 50/50 outcome in investor surveys it is the uncertain consequences of an exit that has raised the risk temperature in Europe once again.
Greece’s 2011 GDP ($312bn) is less than the market capitalisation of Apple ($320bn), but the potential impact of a full default on the 165% of GDP that its debt represents, and the possible withdrawal of deposits by its 10.8m citizens from their domestic banks, makes the potential impact across the European banking system and economies unknown.
Walter Bagehot wrote in 1873: “In wild periods of alarm, one failure makes many…” and the fear of the consequences of a Greek exit from the euro appear to animate investors more than they currently animate the political leaders of the eurozone who continue to behave as if it is inevitable that the Greek politicians and people will act rationally (as the eurocrats define rational) and swallow the unpleasant medicine of domestic contraction in exchange for avoiding the twin catastrophes of a liquidity and a solvency crisis.
But history is littered with irrational financial crises which have devastated that nation’s economy. Some commentators draw comfort from surveys of Greek surveys showing a large majority want to remain in the euro and assume that this means they will vote in the second election in June to achieve that wish. But people everywhere act irrationally, particularly at times of stress. Since it won its independence from the Ottoman Empire in 1829/30 Greece was more or less permanently in default until the mid 1960s according to Carmen Reinhart and Ken Rogoff in their book “This Time It’s Different”.
While Europe has struggled, the United States continues to produce broadly positive economic data, consistent according to ISI with a pattern of +2-3% annual increases in GDP over the next couple of years. There have been stronger data releases in housing, employment, consumer confidence and autos to name bit a few. The National Association of Realtors reported rising prices in most markets, and that housing affordability was at a record low.
The futures contract on the Case-Shiller index closed 4% up last week, and homebuilding stocks have been performing strongly. The University of Michigan’s employment survey was at a record high, topping the 1984 reading which signalled a drop in the unemployment rate from over 10% to under 8%. Asia continues to weaken, with concern over slowing growth in China not being reversed by a further 50 bps cut in the People’s Bank of China’s RRR on Monday.
Yesterday BHP Billiton’s Chairman Jac Nasser and its CEO Marius Kloppers, commented that although Chinese demand should continue to underpin long-term commodity price strength, prices have fallen from their highs as the Chinese economic boom has matured. As a consequence BHP’s capital expenditure plans are being scaled back.
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