The Lowdown on Markets to 17th July 2015
In this week’s issue
- Global equity markets continue to react to what is happening in Greece and China.
- In the US and UK both central banks have indicated that rate hikes are on the horizon.
- In the FX market sterling advances to its highest level against the euro since 2008.
- Equally the dollar trades firmer against a backdrop that the Fed will raise rates in September.
- China’s gold reserves rise as it becomes the sixth largest holder of gold in the world.
- The current backdrop is likely to be uncomfortable for financial markets over the short term.
What does this mean for the markets and asset classes?
“The current backdrop is likely to be uncomfortable for financial markets”
Whilst equity markets continued to react to the events in Greece and China most have been range bound for some weeks with investors showing a clear sign that they are unconvinced about any of the outcomes surrounding the current issues. Indeed, whilst Greece appears to have secured a third and final bailout package their still seems to be plenty of obstacles around the negotiation table, in fact, it would still appear that the International Monetary Fund, Greek Prime Minister Alexi Tsipras, and most of the European politicians do not like the deal and are unconvinced about the longevity of the plan.
Clearly, the Greek crisis is far from over and like the Great Depression of the 1930’s it will be a very long and painful way back for them, whether they are in, our out, of the European Union and the euro. Unfortunately, the situation is such that a complete overhaul of their economy will lead to major reforms within their labor market, pensions, and tax system. However, further austerity is not going to help them in the short-term. Regrettably, Greece still requires a huge amount of debt relief, including haircuts, and the likelihood of them ever repaying these loans back in full is unlikely.
Of course, there is still a possibility that a “white knight” might eventually come to their aid, China, with its vast sums of money, or indeed Russia, could be candidates. Admittedly, that might leave the European Union feeling very uncomfortable, and of course the United States, are fearful that any Chinese support could have longer-term ramifications for the US dollar, and its status as the world’s reserve currency.
However, this could all change over the coming years as the US dollar becomes more susceptible to losing its reserve currency crown. Indeed, China, the world’s second largest economy, has the fiscal clout to compete on a global stage, and of course, the US are very mindful of their ever-increasing presence and are carefully watching events unfold in many regions of the world where China have a vested interest.
Conversely, the recent events that have affected the Chinese stock market, and its economy, have also been closely monitored by the world, given that any meltdown of the Chinese economy has big ramifications for the rest of us. Certainly, the intervention from the Chinese authorities to support their stock market has cost them a huge amount of money, in access of US$1.0 trillion, and to cap all of that, a large percentage of the shares listed on the Shanghai Composite Index became suspended which reflected badly on them.
Arguably, this led to the MSCI deciding not to permit the inclusion of China’s mainland shares into their index for this year; however whilst their credibility has been tarnished over the short-term, it is likely that over the next couple of years this decision by the MSCI will be reversed.
Obviously, China understands what is at stake and a stable economy, stock market and currency will be imperative if Beijing has ambitions to sit at the top table with the likes of the United States, and therefore, any future actions taken by the Chinese Government, and The Peoples Republic of China, will be closely monitored.
Indeed, even over the last few years we have seen China increasing their gold reserves whilst putting in controls to prevent the yellow metal from leaving the country, perhaps indicating its intention to peg the yuan to the price of gold. In fact, China is now the sixth largest holder of gold bullion in the world after the United States, Germany, the International Monetary Fund, Italy, and France.
Unquestionably the Greek crisis, and China, will continue to linger on for some months to come, but putting that to one to one side for a moment, the other real issue of contention for the markets will clearly be the reaction in the market once the Federal Reserve Bank, and the Bank of England raise interest rates. Admittedly, the markets are fully aware of this, and that any hike will be small and carefully managed, never-the-less it is still likely to create a response from global investors.
Obviously Janet Yellen has alluded to the reasoning behind the imminent US rate hike, the economic recovery, consistent fall in the jobs numbers, and the uplift in core inflation, which goes some way to making her decision plausible for September, however, Mark Carney’s decision is less clear. Whilst UK growth has picked up, wages are finally increasing, and business confidence fairly strong, issues such as mortgages and credit card borrowings could be an issue. Indeed, research by the Resolution Foundation has found that even a modest rise in UK rates could see one in four mortage borrowers forced to spend more than a third of their income on repayments.
Another issue of contention for both central bankers will be the effects on the currency; both the US dollar and sterling are likely to strengthen against a basket of leading global currencies, once the US and UK tighten, which in turn is likely to put the brakes on their export competitiveness against the likes of China, Asia and the eurozone given that their central banks are in loosening mode.
Clearly, the remainder of the summer months is going to be uncomfortable for financial markets; in Europe the Greek crisis is unlikely to be resolved, given that Athens and its creditors are still some way off in terms of a longer term workable solution, and of course the survival of the government, the Syriza party, under Alexis Tsipras.
In China, the stock market remains volatile with the government implementing policies and liquidity to try and stabilise the situation and in the US the Fed remains on track to announce their first rate hike for many years. Finally, in the UK the government continues to try and steer a steady course knowing that the eurozone and Grexit still remains a threat. Admittedly, things do sound, and look a little gloomy; hence in some asset allocations cash levels are at their highest level for many years, none-the-less, broadly speaking equities still remains the asset class of choice but execution risk will persist whilst much of the above remains unsolved.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum he worked within larger asset managers, primarily as an Investment Director within Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Investment Committee. This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.