Since the start of May, the situation in a number of distinct market sectors has deteriorated markedly.
A possible disorderly exit of Greece from the eurozone, imbalances in Spain and an obvious slowdown in China have weighed on sentiment and led to a worsening of financial market conditions in the U.S., but also in other important places in the world.
Turning first to Greece, I wouldn’t be surprised at all seeing it leave the eurozone before the year is out. In my opinion, it doesn’t matter at all “who” really wins the Greek election on June 17 because whoever wins the elections, Greece will remain “insolvent,” and that situation will stay with us for a very long time to come. It’s as simple as that.
The only difference the elections could make, depending on if an extreme leftwing coalition headed by the Syriza party wins and the coalition it will have to establish decides to cancel austerity policies, comes back on Greece’s formal promise to reduce public employment and default (again!) on the country’s debt. Then, under such a scenario, Greece’s day of reckoning could happen very soon instead of later in the year. Anyway, I can’t see a nice way out.
As a long-term investor, it could be wise to keep in mind the important message in a new CEPS (Center for European Policy Studies in Brussels) study: “Grexit: Who would pay for it?” The study explains why the “intangible” costs of a Greek exit can simply not be quantified into a figure.
Nevertheless, in the short run at least, these costs consist of contagion in the form of even higher risk premiums for countries like Spain and Italy and the risk of “bank runs” throughout the peripheral EU countries. The “tangible” cost would come in the form of a likely default of Greece on its remaining foreign debt. After the PSI (private sector involvement), Greece owes relatively little to foreign private creditors, but “a lot” to official creditors, which are principally the EFSF (European Financial Stability Facility) and the ECB (European Central Bank) that totals a staggering “plus” 300 billion euros ($375 billion) if one tallies up the various channels through which Greece has received support.
The IMF comes out well as the claims the IMF has on Greece should be serviced in full because they are “indisputably senior.”
No wonder that Switzerland is drawing up plans for emergency measures, including capital controls, in case the euro collapses. SNB (Swiss National Bank) Chief Thomas Jordan told the Swiss weekly Sonntagszeitung: “We must be prepared for the worst case, under which the euro currency union falls apart, even as I don't expect this to happen … One measure could be capital controls, meaning measures that directly affect the inflow of capital into Switzerland.”
From its side, Lloyd's of London has also drawn up emergency plans to deal with a collapse of the euro. Richard Ward, Chief Executive of the specialist insurance market, said: “I don't think that if Greece exited the euro it would lead to the collapse of the eurozone, but what we need to do is prepare for that eventuality.”
Yes, we could say: “We have been warned by serious sources beforehand!”
Talking about Spain for a moment, we could summarize it as follows. We further continue discovering one black hole after another in the Spanish “twilight zone” that is mainly centered around:
• its housing market that so far has fallen over 21 percent since the beginning of 2008 with the pace of declines now accelerating with y/y decline of -7.2 percent and Q1 of 2012 printing -3.08 percent alone, and
• the IIF (International Institute of Finance) now (not final!) estimates that Spanish bank loan losses could hit 260 billion euros or about 325 billion dollars.
By the way, the Madrid Stock Exchange’s subindex of banks and savings banks (called “cajas” in Spanish) is down 44 percent y/y and 30 percent q/q. Please take notice the cost of a five-year CDS (credit default swap) on Spanish sovereign debt is now about the same of insuring sovereign debt of Hungary and Jamaica.
Finally, the 10-year yield gap between Spanish and German sovereign debt continues to widen out (early Tuesday at +516 basis points, which is a fresh euro-era record), which obliges me (unfortunately) to think back at where the Greek bond spreads over the German bunds were two years ago. What happened afterwards, we all know.
Beyond Europe, China has also become a source uncertainty because recent data are the weakest since 2009 and without any doubt below market expectations.
Commenting on the Flash China Manufacturing PMI survey that was released last week, Hongbin Qu, China & Co-Head of Asian Economic Research at HSBC said: “Manufacturing activities softened again in May, reflecting the deteriorating export situation. This calls for more aggressive policy easing, as inflation continues to slow. Beijing policy makers have been and will step up easing efforts to stabilize growth, as indicated by a slew of measures to boost liquidity, public housing and infrastructure investment and consumption. As long as the easing measures filter through, China will secure a soft landing in the coming quarters.”
Nevertheless, I think that, if things don't deteriorate further, China is unlikely to implement a real “big” stimulus package (bazooka-like intervention), given the still-existing inflation risks and the fact it has no longer the firepower available it had in 2009.
Of course, if Europe crashes, all bets are off, and we could expect a real big stimulus package in China, regardless where inflation could go afterward.
In the U.S., last week’s Markit Flash (85 percent of all final data) U.S. Manufacturing PMI indicated a positive improvement in the U.S. manufacturing sector business conditions. However, with the seasonally adjusted PMI falling from 56.0 in April to 53.9, the headline PMI nonetheless signaled the weakest expansion in three months.
We could say the U.S. manufacturing seems to be repeating the trends seen in the previous two years, whereby a strong start to the year loses momentum as summer approaches.
This year, the cause seems to be largely with weak export sales, which likely reflects the deteriorating economic situation in Europe as well as slower growth in China.
Irrespective of a U.S. seasonally adjusted PMI slowdown in May, it still is encouraging to see producers continuing to add to their payroll numbers in the expectation that demand will continue to rise in coming months.
Furthermore, producer price pressures have eased substantially, largely because of weaker commodity prices in recent weeks, which bode well for the inflation outlook for the time being.
Nonetheless, long-term investors should remain cautious and keep in mind that unless demand picks up, the slowdown might continue into June, and payroll growth would logically suffer as a result.
Don’t overlook the forward-looking ratio of new orders to finished goods inventories fell to its lowest level since July 2011, which suggests manufacturers’ warehouses are holding too much stock relative to order books.
I wouldn’t be surprised to see a small decline in the ISM manufacturing index to be released on Friday, which should be consistent with a situation of solid manufacturing growth in Q2, albeit at a softer pace than the strong gain in Q1.
Nonetheless, since the start of this month there is evidence of a fresh, albeit timid slowdown as well as a worrying shift in sentiment in the previously inviolable technology stocks sector with, in some cases, distinct echoes of the first months of 2000.
Of course, nothing is written in stone. Greece could elect a pro-austerity government, China could successfully stabilize its overall slowdown and the slowdown in the U.S. could prove to be only temporary.
I wouldn’t bet on such a rosy scenario, but, as always, everybody will have to make up his/her own mind before taking investment decisions.
I still believe, as things are developing these days, 2013 doesn’t bode well, and this doesn’t take into account at all geopolitical risks, of which the Iran situation claims the pole position.
I’m still convinced there will come interesting buying opportunities in many places, and includes Developed (DM) as well as Emerging markets (EM), but we aren’t there yet … no, not by a long shot, as the horizon stretches into 2013-2014, but that is strictly my personal opinion. Anyway, I wouldn't trust any relief rally ...
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