24th August 2015
The usual summer doldrums have suddenly been whipped up into a ferocious storm as markets are spooked by every piece of negative macroeconomic news concerning China, Greece, global growth and the timing of an interest-rate hike in the US. Andrew Parry, head of equities at Hermes Investment Management, asks: how justified are these concerns?
Greece’s direct impact on the European economy, let alone the global one, is limited, but the ongoing negotiations to rehabilitate its economy and manage its vast debts are pivotal to the future of the eurozone project. With €320bn of government debt, it is fanciful to think that another bailout, this time of €86bn, will suddenly resolve the challenges.
Politics – domestic and across the eurozone – lie at the centre of the struggles to put Greece on a sound footing. It was the politics of the euro that dictated that there would be another bailout, rather than a Grexit, as Greece leaving the eurozone would demonstrate the fragility of the currency and open the door for other profligate or slow-growing countries to come under pressure. Without the euro, Greece would default – as it has done 13 times before – devalue its currency and then try to rebuild its economy from the rubble, as has Iceland after its 2008 collapse.
Given the scale of its debts and the impact of another recession, a Grexit always seemed the logical outcome to many, but that would undermine the entire eurozone project. Since 1 January 2000, the Greek economy has had zero cumulative real GDP growth, even after an initial boom. In that same period, the Italian economy has also recorded no real GDP growth, and it too has vast debts. Take away the comfort blanket of implied mutualisation of debt across the eurozone and a currency with limited purpose is revealed. Perhaps this is why French President François Hollande worked so hard to keep Greece in the euro?
Now the uncertainty of a domestic political battle in Greece is turning investors’ attention back to the country and the probability of its debt restructuring being successful. For Greece to remain in the euro, debt forgiveness is inevitable, and this outcome is likely because the rest of the members of the eurozone cannot afford for Greece to leave.
China: markets catch up with slower growth
Meanwhile, on the other side of the world, China has completely reversed its New Year euphoria and the Shanghai Composite Index is flat for the year to date after a 38% fall from its June peak. Slowing growth – more 4.5-5% than the official 7.1% — has taken investors by surprise, though many ‘real world’ indicators have suggested moderating growth all year. The devaluation of the yuan after the government’s decision to fix it each day to the spot price of the previous close, and the knock-on impact on other Asian currencies, has added to the confusion, with some commentators divided between viewing this as part of a panicked reaction to weakening demand and those, including us, who see it as part of the long-term and well flagged structural reform of the Chinese economy.
Growth in the developing world has been sliding all year, as a combination of weak commodity prices after the end of US quantitative easing last October, poor economic management and high debts have started to take their toll. We have been concerned about global growth, as this could be the fifth consecutive year that the global GDP growth rate has declined. At the same time, global trade has slowed more sharply, suggesting that the export-led recovery expected by devaluing nations, the Eurozone in particular, will not happen.
The US is beginning to wake-up to this reality. The trade-weighted US dollar is marking new heights, compounding a slowdown in corporate profit growth, which looks vulnerable after six years of expansion. An interest rate rise by the Fed – more a virility symbol for the US economy’s robustness than an immediate economic necessity – would only compound the angst gripping investors. We expect Fed Chair Janet Yellen to stay her hand in September, as a consequence.
Positives: Western growth and market bargains
While it is easy to get caught in the panic, we should also be prepared to look for the positives. Lower energy prices will provide a modest boost to consumers’ disposable incomes, and while growth in the West might not be exciting, it is growth nonetheless, and in the eurozone it is being led by the domestic economy. The collapse in stock prices has also restored some value to markets starved of bargains, which is always the benefit of a dose of fear. The bond market rout of a few months ago seems a distant memory, and investors have flocked back to the safety of government securities, illustrating how succumbing to fear can be dangerous. Furthermore, the authorities are not going to stand by idly, so we can expect more policy responses to come. With the euro fetching nearly $1.15, the European Central Bank will not want to risk the burgeoning but still immature recovery to be snuffed out. In this environment, we believe it is prudent to follow the growth.