Posts tagged ‘Europe’
So this week London entered a bear market. Some commentators discern echoes of the “2008 financial crash”. Sage market participants – who have been warning us about China* / Emerging Markets* / the Euro* / QE* / Commodities* / Debt* / Deflation* / Monetary Tightening* [*delete as appropriate] – for several years have finally been proved right. Several of them caution, sagely, that we should remain cautious as it could have further to go.
Yes, this week, the FTSE 100 Index entered a “bear market”, as defined by a fall in value from its closing peak (7,103.98 on 27 April 2015) of at least 20% – 20.14%, to be precise, reached on Wednesday with a closing price of 5,673.58. It should be obvious that this signifies nothing whatsoever more than a fall of 18% or 19% but there we are. Markets have their conventions. This is now, technically, a “crash” rather than a “correction” (a fall of between ten and twenty percent). And some would have us believe it’s 1929 all over again.
Such, however, it cannot be. Global equity (as measured by the MSCI World Index) has not entered a bear market – it has fallen by 17.62% from its peak – and this is entirely due to Wall Street. The S&P 500 has shed a mere 12.74% from its heady peak last May. Since the US market makes up a little under 60% of the developed world’s total market cap this more than makes up for the fact that Tokyo and … erm … Brussels? … have entered bear markets alongside London with the TOPIX and Euro Stoxx 50 indices down 23% and 25% respectively.
Even here in the UK the crash is not that clear cut. The mid cap FTSE 250 Index has shed only 14%, with the small cap index having done slightly better. Considering the fundamentals this is understandable. There are few oil supermajors bestriding this particular corner of the marketplace, or mineral colossi. The much vaunted overseas exposure of the large cap index has been, at best, an equivocal strength with the UK economy doing as well as it has (not to mention the distorting effects of all that foreign exchange exposure). So the current infestation of bears has been locally as well as globally selective.
Still, who needs “fundamentals” with all that lovely panic to go around! Surely it can only be a matter of time before those other columns tumble? After all, it’s 2008 all over again!
Except, of course – it isn’t. Not even remotely so. Back in 2007, to refresh our memories, there was a massive over-extension of credit via packaged structures that were as poorly valued and understood as they were widely held. A few mortgage arrears in the US later and the world’s financial system suffered cumulative capital losses just shy of $2trn and would have collapsed without the $1.5trn of capital that then had to be pumped into it, mostly by governments. Then in the autumn of 2011 it looked as though the bond market might close to Italy. Since the Italian economy is rather large, with a commensurate burden of sovereign debt, it was certain that neither the IMF nor its sponsoring governments would have been able to afford a bailout. At that point we could have seen governments across the developed world plunged into default.
Now that would have been a disaster.
And what is behind the doomsaying today? The rate of GDP growth in China down by 0.1%! Oil falling – which is admittedly more dramatic – but unlike the financial crisis will prove an economic benefit on average (and perhaps delay the need for monetary tightening in Britain and elsewhere). Or perhaps it is simply the case that the bull market run since 2009 got ahead of itself and equities are anticipating the forthcoming change of cycle.
On that last point there is something further to be said about all those crashes and corrections. Amid the justifiable fear of 2011 the S&P 500 had a peak-to-trough fall of 19.4%. Admittedly, this is a whole 0.6% short of a full-blown bear market, or “official” crash. But it was not much fun for investors at the time. And away from the US, stock markets have had a much more equivocal rally. While the S&P raced ahead during 2013 and 2014 for instance, returning 50% over those two years, the FTSE 100 returned only 20%. In Japan, suffering from the earthquake and tsunami of 2011 and their aftermath, the market did not even start to climb until the tail end of 2012. The years since the credit crunch and Great Recession have seen healthy equity market returns – at times, in some places, and in fits and starts. But it has not been any sort of eye-watering, valuation-busting rocket trip.
We are where we are. But the crash has been as partial as the bull run, the panic is hard to justify – in some respects, even, absurd – and it may yet prove that all the doomsaying is being listened to just a little too closely.
The market’s focus of late has been on the Fed, US growth and China. There has been news out on all three in recent days – but there has also been some news out on Europe.
This week saw further agreement on an EU-wide framework for banks (specifically as regards the topical subject of bailouts). It accompanies ongoing work on arrangements for federal – sorry, supranational – oversight of national budgets.
News on European affairs passes with little comment these days. This would have been unthinkable a short time ago. When budgetary oversight was agreed about 18 months ago it was headline news across the world. And the catalyst for the whole sequence of emergency summits, the insolvency and bailout of Greece just over three years ago, was of course seismic: during the week after the bailout announcement itself, the Euro Stoxx 50 index fell by over 11%. Then, after the attention-grabbing trillion dollar support package for the whole eurozone was announced the following Sunday, it rallied by over 10% in a day.
Now there is no such excitement. Like the banking system and budgetary oversight measures, the emergency EFSF and ESM programmes have come along quietly – from zero to just shy of €200bn in funds raised in three years. Once upon a time – when eurozone bond markets went haywire in 2011 – the then ten-year EFSF bond, backed by guarantees from all eurozone sovereign states, traded briefly at 2% over the yield on its German government benchmark. Now that spread stands at 0.6%, and despite all the volatility has dribbled along in a range of 0.4% – 0.7% all year.
This is quite a turnaround. From star of the show (albeit as anti-hero), Europe hardly seems to appear on stage any more. Which begs the question: are we being complacent? Do arguments over 0.5% vs 0.3% on US incomes and 7.0% vs 7.5% growth in China miss the bigger point? Has the European crisis become the elephant in the room?
As a bear case it is a tempting proposition. Just when we have all started ignoring Europe, a new bailout or political upset will come along and upset the apple cart again. If only those headstrong Eurozoneans would adopt an expansive approach to fiscal policy and improve their competitiveness via currency devaluation, etc., they might enjoy the kind of economic success which characterised Britain in the 1970s (this blog has never fully understood the logic of this confidently-touted advice).
There is an alternative, of course. A slew of indicators in recent weeks, from activity gauges to measures of confidence, have shown that the beaten-up Continental economy might at last be turning the corner and emerging from its painful though shallow slump into the anguished and shallow upturn its central bank expects.
Still, the pace of recovery in Europe doesn’t matter so long as it finally occurs. No one thinks of Europe as the engine of world growth. But it is obvious that the benefits of entrenchment in activity there would extend to those countries who are seen that way (China, for instance).
Without wishing to extend the list of animals too far: if Europe turns out to be the elephant in the room the bears will undoubtedly have their day. Otherwise – at some point – it will be the turn of the bulls again.
While we haven’t seen anything like the Arab Spring this year, it has not exactly been politically quiet. The recent general election in Italy, for instance, got a lot of international attention, and the new parliament has opened amid wrangling and apparent deadlock. But the market reaction so far has been very muted.
When Greece held inconclusive elections last May, European stock markets continued a decline powered by renewed concerns over the eurozone crisis, with the FTSE 100 and the Stoxx 50 both ending the month about 5% lower. Since the Italian elections this year, however, both indices are up. The Milan bourse itself is flat. Ten year government bond rates in Italy have risen by all of 14bp, and the spread to Germany remains tighter on the year to date. (Last May the increase in the 10-year yield was 50bp.)
After all, electoral chaos in southern Europe is nothing new. Since the end of the military junta in Greece in 1974 there have been twelve prime ministers (not counting two caretaker-leaders), and fifteen elections during the course of which the vote counting system was changed four times. The story in Portugal is almost identical: thirteen elections and prime ministers since the establishment of constitutional government in 1976. Italy has held eleven general elections since 1974, only one more than the UK – but it has had more than double the number of prime ministers over the same period (seventeen versus seven), a reflection of the volatility of its fragmented coalition politics.
This is not to disparage the significance of politics in these countries. Much of the interest in events in Italy centres on the popularity of the anti-establishment Five Star Movement, which won over 25% of the vote on the concise though administratively opaque campaign motto, “F- Off”. It remains to be seen how exactly the message will be interpreted by the political class. And of course the situation could have been worse. Unlike the Greeks, the Italians gave their gaggle of far right parties less than 1% of the vote, and the communist alliance did little better. (Neither won any seats.)
In Portugal, the politics leading to the 2011 election were pivotal in the country’s request for a bailout – something which it might otherwise have chosen to avoid. Likewise, the defeat of Spain’s Jose Zapatero later that year presaged austerity measures and budgetary embarrassment for his successor reminiscent of the “I’m afraid there is no money” line which confronted the UK’s incoming coalition in 2010.
If the focus on European politics continues to diminish, then, it will be further evidence that the world is returning to normal. Changes in government and electoral emergencies in countries like Italy will once again be taken in people’s stride. After all, just look how little excitement there is over the latest EU summit going on in Brussels today – there is coverage, but it hasn’t made a single British front page. Similarly, it would have been easy to miss Ireland’s successful return to the bond market this week with €5bn of 10-year paper carrying a coupon of 3.9%.
The sovereign debt problems faced by countries in the eurozone and elsewhere are far from solved. But in terms of investor confidence and world sentiment, we should remember the old adage: no news is good news.
This coming Sunday sees a presidential election in France and parliamentary elections in Greece. In the case of France it looks probable that we are to lose one half of the “Merkozy” double act that has presided over the eurozone crisis so far. When it comes to Greece the only certainty is that caretaker prime minister Lucas Papademos will no longer be in charge. Would a left wing President of France mean the abandonment of fiscal consolidation? And could popular discontent in Greece bring about demands for a renegotiation of the country’s bailout agreement, with all the chaos that could entail?
The risk from France would seem to be the lesser of the two. M Hollande, the socialist frontrunner, has certainly used the austerity issue as a stick for beating his rival. He has also threatened to refuse to ratify the European “fiscal compact” agreed at one of last year’s many emergency summits unless various measures are taken to boost growth. Crucially, however, he is committed to a remarkably similar domestic fiscal path to that envisaged by M Sarkozy. Both men would see France’s budget deficit reduce to 3% of GDP by 2013 (from an expected 4.4% this year), and both want to balance the budget thereafter – though M Hollande would see this goal reached only in 2017, a whole year later than his opponent, and favours a 50:50 split between tax increases and spending cuts, as distinct from the radically different 35:65 split on the table at present.
At the European level, even the threat to scupper the fiscal compact would depend on failure to agree measures such as those in M Hollande’s four point plan for growth: eurozone-wide bonds for infrastructure projects, more lending by the European Investment Bank, a financial transactions tax and more efficient use of EU structural funds.
Now the idea of using EIB lending to stimulate growth appeared as far back as last July’s EU agreement over Greece, so this could be a serious runner. Chancellor Merkel has already indicated that the next EU summit, in June, will have a growth agenda. If M Hollande manages to secure backing for even one or two of his proposed ideas he would be able to present this as a transformative victory for a more pro-growth politics across the Continent – especially if more EU money for France should happen to be an incidental consequence of the plan. Having already accomplished his most important task – getting elected – his need to tear up the fiscal agreement would be greatly lessened. (This is certainly the way markets are betting, with French bond yields showing no signs of panic.)
The Greek situation is altogether more unpredictable. The electoral system is a model of proportional representation in action. Like the Spartan force at Thermopylae, the legislature has 300 members. 250 of these are allocated proportionately, with a threshold of 3% necessary to win the minimum 8 seats in parliament. The remaining 50 are awarded to the party with the most votes. That will almost certainly mean the centre-right New Democracy party of Antonis Samaras; with poll numbers in the low 20s, ND is several points clear of its nearest rival, the centre-left PASOK, at the head of a very divided field.
Now Mr Samaras has already committed himself, in writing, to Greece’s bailout terms, on the insistence of his country’s creditors. He intends to govern with the aid of PASOK in a continuation of the coalition which has been in place since the fall of George Papandreou last November. But the problem is that the main parties are so unpopular that even with that 50 seat bonus they might still struggle to achieve a majority. The communists, the other leftist parties and most of the nationalist right is against the austerity programme.
In other words, there is a more obvious worst case outcome for Greece. While the communists, nationalists etc. are highly unlikely to join a formal coalition against the political mainstream, they could easily unite to oppose specific votes / budgetary measures, holding out the prospect of fresh elections and constant political uncertainty into the bargain. Anything short of a clear majority for the main parties, therefore, could spell more market drama.
There are of course many observers who would like to see the country’s present rulers out of office, democracy restored, Greece out of the euro, austerity ended and the EU itself given an enormous bloody nose. Despite everything, however, while the most recent polls show that 60% of the electorate oppose an ND / PASOK coalition, 77% “would like the next government to do everything possible for Greece to remain in the euro area”. Whatever else it might be, the political situation in Greece is not that straightforward.
In conclusion, then, the French election over the weekend will be interesting. But the Greek elections could be important.