Commentary: World in Motion?
Markets are adaptive. A pro-Euro election result in Greece on June 17th and a eurozone pledge of €100bn to support Spanish banks would have produced powerful market surges twelve months ago. Instead, this past month, they have provided a brief tonic which quickly went flat. The euro zone’s leaders should reflect on that when they meet later this week in Brussels. Fire fighting individual national crises is clearly no longer enough. The 10 year bond yields of Spain and Italy have retreated from their highs, but at 6.35% and 5.77%, investors still require a significant premium to hold them over the bonds of France (1.92%) and Germany (1.58%).
Last week’s G20 summit saw the Club Med countries proposing that the European Stability Mechanism (and EFSF) bailout funds be redirected to buy the debt of governments under pressure (eg Italy and Spain). Germany resisted both this and the idea of joint “euro bond” issuance. They did agree with France, Italy and Spain to develop a €130bn “growth” package. The debate will continue at this week’s euro summit with increasing pressure to deliver more structural solutions, even if everyone knows any such solutions will take an age to implement.
Evidence of the painful slippage in economic activity emerged in last week’s preliminary June PMI surveys. The euro zone as a whole fell to a three year low, down to 44.8 from May’s 45.1. Germany and France are both in contractionary territory, but France strengthened while Germany weakened. According to ISI, eurozone construction activity has fallen 25% from its 2007 peak, back to 1992 levels.
The potential strain of contraction on the banking sector is clear, and for the second time in two months the ECB announced that when lending to European banks it will accept a broader range of collateral and lower quality assets, estimated as equivalent to an additional €100bn of support. Ironically Moody’s announced a series of downgrades to UK banks, and EU and US investment banks.
Elsewhere in the world economic growth continues to struggle from the effects of the continuing deflation of the debt bubble, despite stimulative policy initiatives. There have been signals from weaker commodity prices with crude oil off 10% so far in June, and the GSCI down more than 5%. Weekly unemployment and jobs data in the US suggests a softening, and last Thursday’s Philadelphia Fed survey of manufacturing activity in the Philadelphia area fell to its lowest level in ten months.
Central banks have responded to the slowdown in growth data. The Fed announced the extension of “Operation Twist” to next January, and Chairman Bernanke made it clear they would be prepared to take further action (ie QE 3). The Bank of England’s Monetary Policy Committee announced no further action but their minutes suggested most members believe further action will be required. During their annual Mansion House speeches the Chancellor and the Governor announced two new initiatives to push cheap credit into the economy, the £100bn Extended Collateral Term Repo Facility for bank funding and the £80bn “funding for lending” scheme to back small business lending by banks.
Markets last week produced a modest positive gain in sterling from global equities overall (MSCI ACWI up 0.3%) driven by Japan (+1.5%), Europe ex-UK (+0.9%) and Health Care (+1.7%). Energy stocks slumped 2.3% on the falls in the oil price and Asia Pacific struggled (-0.1%). America was flat in sterling.
Month-to-date so far the ACWI is up, +1.3%. Large stocks have continued to outperform small; developed to outperform emerging; and value stocks have begun to outperform growth. The rally by oversold Europe has attracted attention because of the low headline valuation of European stocks, currently 10x next year’s earnings according to FactSet. But this obscures the continuing influence of the Financial sector, still 18% of the MSCI Europe ex-UK index. If financial stocks are excluded the balance of the index is valued at 13.3x next year’s earnings.
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