Zorba and the banks
Global Investor Report - Monthly News for Global Investors 25 June 2015

No in fact this is not a follow on novel to the infamous Zorba the Greek, though one could be mistaken for thinking it is a Greek tragedy. Instead the final act of the Greek story appears to be playing out with the Eurogroup (Eurozone finance ministers) and Ecofin (EU finance ministers) all meeting to urgently agree the way forward/out for Greece.

Greece desperately needs to find agreement on its debt payments by the end of June as this is when it is required to pay down part of the International Monetary Fund facility of $2.3 billion (€1.6 billion). The real deadline is really before the end of the month as there needs to be sufficient time to allow for the German Bundestag to adopt the bailout measures.

In negotiations with the Greek Government, Angela Merkel, the German Chancellor is quoted as saying that Greece's most recent offer made "some progress". But as she said previously "time is short".

Even if agreement is reached, it is unlikely to help solve the Greek woes, in fact, it would more than likely mean another (third) bailout or debt restructuring before the economy would begin to return to positive growth. Economists are currently expecting Greece’s GDP to contract by 0.2% this year.

In addition to the chance of Sovereign default, individual savers have lost confidence in the local banking system which has led to huge withdrawals of $5.8 billion (€4 billion) in recent days and a banking system on the verge of collapse.

The contraction of the economy doesn’t however take into account the scenario where no agreement is made by the end of June and payment is not forthcoming to the IMF. This would lead to a similar situation to Cyprus, with capital controls put in place for a period of time. The knock-on consequence is likely to be strong recession, a credit crunch and possible payment delays.

Ultimately Greece would need to restructure all of its debt which currently sits at approximately 180 per cent of its entire annual economic output. This would seem to be the only way that Greece could escape a vicious cycle to secure additional funds to meet creditors’ demands. Reneging on its debts would allow Greece to get a fresh start but it would also mean the government would have to close its financing gap and restrict spending to income. For the Government this would mean creating a financial discipline that Greece has not seen for decades, a clean slate would be great, but the responsibility that goes with reform means the Greeks would rather go for bailout as a first option.

Of course the economics do not take into account the opinions of the voters and in Germany there appears to be a growing sense of impatience with the Greeks, while in Greece, the hard-left Syrzia supporters are a potential roadblock to the Prime Minister in passing economic reforms, even those required for a debt deal.

Unfortunately, whatever happens to the Greeks, it would appear that the Euro experience was a failure for them. There are pundits on both sides of the single European currency issue, those for and those against, but a prevailing argument is that joining the Euro ultimately led to Greece’s catastrophe. Boris Johnson, the British politician and Mayor of London, recently remarked: “They were mad to abandon the safety valve of an independent monetary policy, and they are paying for that folly in a daily and escalating human tragedy: of falling life expectancy, of rising suicides and mass unemployment; of medicines they can no longer afford, of operations cancelled and hope extinguished.”

Russia will prioritise economic stability

It has been noted in the press that Russian President Vladimir Putin and Greek Prime Minister Alexis Tsipras both spoke at the St Petersburg International Economic Forum (SPIEF) on 19 June. Intrigue has been raised around Russia’s support for Greece with its economic problems.

However, of more interest is that the forum gives great insight into the economic confidence in Russia. The take away message: the Kremlin is to concentrate on safeguarding economic stability in this era of geopolitical instability rather than instigate reforms.

The realities of the economy are very stark. A second estimate by RosStat showed that first quarter real gross domestic product contracted by 2.2 per cent (year on year), this is a revision declining from the previous 1.9 per cent estimate.

The only parts of the economy that expanded were agriculture (2.9 per cent YOY) and mining (4.9 per cent YOY). The consumer and service sectors saw huge contractions indicative of a substantial fall in private consumption with a 25.5 per cent decline in property, 22.1 per cent decline in trade and 19.5 per cent decline in tourism (hotels and restaurants).

Financing remains difficult which has the knock-on consequence of investment cut backs. The Central Bank did see a slight easing in inflation in May (15.8 per cent YOY) which meant that they lowered their key policy interest rate to 11.5 per cent.

President Putin in his key-note speech remains optimistic and defiant at interference in the Russian markets by other countries with the “restricted access to the global capital market” and the “drop in prices for…main export goods”. But the overall message is positive: the “budget is stable”, the “financial and banking systems have adapted” and they have “prevented a jump in unemployment”.5

The ultimate test for Russia will be whether the open doors policy is working, whether the President really can turn the economy back around with new partners. He states that foreign companies are opening their doors in Russia including a “pharmaceuticals company” and “a company producing gas turbines as a joint venture with foreign partners”. The ultimate test will be whether business and investment are comfortable to put their money back to work in Russia.

China prospects

Closer to home there are still mixed messages coming from China. The HSBC/Markit flash manufacturing purchasing managers' index (PMI) was at a three-month high of 49.6, an increase from 49.2 in May, outperforming the forecast of 49.4.

The reading remains under 50 which is the mark dividing contraction from expansion. However, even with factory activity contracting for a fourth month in a row the June figures signal possible stabilising.

Other encouraging signs of growth include the real estate sector with the market growing by 0.2 per cent (month on month) in 70 major cities – the first growth in 13 months.

With this growth we have also seen an increase in foreign direct investment (FDI) which rose in May by 7.8 per cent YOY. This is a rise from 2.2 per cent in February this year.

It would appear that the Government’s strategy for accommodative measures are having some success. There has not only been growth in money supply but also aggregate financing flows. This includes bank finance as well as off balance sheet credit, which rose to $254 billion (CN¥1,220 billion) in May from $219 billion (CN¥1,050 billion) in the previous month.

The continued economic policies of the Chinese Government are likely to see further FDI as well as an improvement in financing conditions, more monetary easing and further advances in financial liberalisation – all of which may actually lead to Chinese President Xi Jinping’s “new normal” growth target of 7 per cent gross domestic product in 2015.6

Change is coming...

The Federal Reserve in America has kept interest rates unchanged, the median estimate for the Fed Funds rate at the end of 2015 remaining the same at 0.625per cent. However, they have indicated that rate rises are on their way, citing labour market conditions and inflation as not yet warranting an increase.

In a press conference on 17 June, the Chair of the Federal Open Market Committee, Janet Yellen, said that "most [policy-makers] are anticipating a rate increase this year".

The policy statement7 issued by the Federal Reserve is positive, stating that “economic activity has been expanding moderately... [and that the] underutilization of labor resources diminished somewhat… and the housing sector has shown some improvement”.

As such the National Association of Home Builders/Wells Fargo housing market index gained 5 to 59 in June and housing permits rose for the second month in a row by 25 per cent YOY in May.

Indeed, retail sales rose for a third month in a row in May. But there are some negative numbers appearing as well, such as the contraction in industrial production by 0.2 per cent, the fourth fall in the last half year, as well as the number of new residential construction projects starting in May dropping by 11 per cent.

With each of these factors it would be hard to see a rate increase prior to the fourth quarter, this being particularly the case with inflation expected to remain below the 2 per cent target (the Producer Price Index8 in May was at a low 0.6 per cent YOY), and fewer jobs than workers in the labour market.

For the investor these are turbulent times, there is a lot of upheaval in the world at a geo-political level. But people are still moving on with their lives as can be seen in some of the economic data coming out of places like China and the US. And while there will always be instances of instability such as Greece and Russia, it would seem, at least, that many investors have learnt to compartmentalise their investment exposure sufficiently that they are not overly-exposed in any one market, are able to take advantage of emerging opportunities where they can, but also sit tight in developed markets, which though cyclical, offer consistent returns in the long term.

Best regards,

Martin Barry
Vice President,
Chief Wealth Management Officer

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5. http://en.kremlin.ru/events/president/news/49733 6. http://news.xinhuanet.com/english/2015-03/29/c_134106145.htm 7. http://www.federalreserve.gov/newsevents/press/monetary/20150617a.htm 8. A release from the Bureau of Labor Statistics (BLS) produced monthly that shows trends within the wholesale markets (http://www.bls.gov/ppi/)
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