Global Investing

Weekly Radar: In the shadow of the cliff

It’s been another rum old week market-wise, with global stocks off another 2 percent or more and recording seven straight days in the red for the first time since August. Throw any spin you like at the reasoning, but the pretty predictable post-election hiatus on U.S. fiscal cliff worries now seem to be front and centre of everything. And that will just has to play itself out now, leaving markets stuck in this funk until they come up with the fix. The running consensus still seems to be that some solution will be reached, but no one wants to be too brave about it. And given the cliff is one of the few good explanations for the sharp divergence between the equity market and still rising US economic surprises,  you can see why many feel the US fiscal standoff is merely delaying a resumption of the rally.

The euro zone story has rumbled again of course, with the Greek hand-to-mouth financing, pressure for official sector debt write-offs there and another nervy wait for the latest tranche of bailout funds. Anti-austerity protests in Greece, Spain, Portugal and elsewhere meantime stepped up a gear this week and Q3 data out today confirmed the euro bloc back in recession.

Yet Europe is not the main driver of global markets at the moment. The latest MerrillBoA funds survey this week showed that, at 54%, more than twice as many funds now think falling off the US cliff and not the euro crisis is the biggest global investment risk. The euro group meets next week on Greece  ahead of a two-day EU summit and we still have no clarity on Spain’s bailout either. There’s plenty of headline risk then, for sure, and the parallel release next week of November PMIs is hardly going to bring sweetness and light. That said, there’s been about as much good as bad news from Europe of late. The ECB is simply not going to pull the plug on Greece even if OSI gets pushed up to governmental level and take a lot more time. Spain and Italy have both now effectively completed funding for this  year and there were very positive noises this week on Ireland returning to markets in early 2013 with a 10-year syndicated dollar bond, while Fitch raised its sovereign rating outlook to stable from negative.

So, generalised cliff gloom seems to have hit all risk markets indiscriminately. Over the past seven days, equities are lower, EM equities underperformed, Treasury and bund yields are down again (German 2-year back negative) and peripheral European yields have nudged back up again too. The dollar’s a little higher on the euro. On the other hand, oil and commods are up a bit – though that has as much to do with renewed MidEast tensions.  What’s more,  commodities in general are one of the few macro price gauges still in the red for 2012  — so to the extent that some of the global market pressures are related to year-end profit taking, then they may be in different territory.

All in all, this looks like a tired rather than overly anxious market. Implied equity vol remains relatively low and euro/dollar FX vol hit another five-year low this week.

Next week: Half time…

QE, some version of it or even the thought of it, seems to have raised all boats yet again — for a bit at least. You’d not really guess it from all the brinkmanship, crisis management and apocalyptic debates of the past month, but June has so far turned out to be a fairly upbeat month – weirdly. World equities are up more than 6 percent since June, lead by a 20 percent jump in European bank stocks and even a 20 percent jump in depressed Greek stocks. The Spanish may found themselves at the centre of the euro debt storm now, but even 10-year Spanish debt yields have returned to June 1 levels after briefly toying with record highs above 7%  in and around its own bank bailout and the Greek election. And the likes of Italian and Irish borrowing rates are actually down this month.  Ok, all that’s after a lousy May that blew up most of the LTRO-inspired first-quarter market gains. But, on a broad global level at least, stocks are still in the black for the year so far. It was certainly “sell in May” yet again this year, but it’s open question whether you stay away til St Ledgers day in September, as the hoary old adage would have it.

On the euro story, the Greeks didn’t go for the nuclear option last weekend at least and it looks like there are some serious proposals on the EU summit table for next week – talk of banking union, EFSF/ESM bond buying programmes, euro bills if not bonds, EIB infrastructure/project bonds to try and catalyse some growth,  and reasonable flexibility from Berlin and others on bailout austerity demands. The Fed has announced that it will twist again like it did last summer, by extending the Treasury yield curve programme by more than a quarter of a trillion dollars, and there are still hopes of it at least raising the prospect of more direct QE. The BoE is already chomping at that bit, as well as lending direct to SMEs, and most investors expect some further easing from the ECB in the weeks and months ahead.

Of course all that could disappoint once more and expectations are getting pumped up again as per June market performance numbers. The EU summit won’t deliver on everything, but there is some realization at least that they need to talk turkey on ways to prevent repeated rolling creditor strikes locking out governments out of the most basic of financing — only then have those very same creditors shun countries again when they agree to punishing fiscal adjustments. A credible growth plan helps a little but some pooling of debt looks unavoidable unless they seriously want to remain in perma-crisis for the rest of the year and probably many years to come. It may be a step too far before next year’s German elections, but surely even Berlin can now see that the bill gets ever higher the longer they wait.

Picking your moment

Watching how the mildly positive market reaction to this weekend’s 100 billion euro Spanish bank bailout evaporated within a morning’s trading, it’s curious to look at the timing of the move and what policymakers thought might happen. On one hand, it showed they’d learned something from the previous three sovereign rescues in Greece, Ireland and Portugal by pre-emptively seeking backstop funds for Spain’s banks rather than waiting for the sovereign to be pushed completely out of bond markets before grudgingly seeking help.

But getting a positive market reaction to any euro bailout just six days before the Greek election of June 17 was always going to be nigh-on impossible. If the problem for private creditors is certainty and visibility, then how on earth was that supposed to happen in a week like this? In view of that, it was surprising there was even 6 hours of upside in the first place. In the end, Spanish and broad market prices remain broadly where they were before the bailout was mooted last Thursday — and that probably makes sense given what’s in the diary for the remainder of the month.

So, ok, there was likely a precautionary element to the timing in that the proposed funds for Spanish bank recapitalisation are made available before any threat of post-election chaos in Greece forces their hand anyhow. It may also be that there were oblique political signals being sent by Berlin and Brussels to the Greek electorate that the rest of Europe is prepared for any outcome from Sunday’s vote and won’t be forced into concessions on its existing bailout programme. On the other hand, Greeks may well read the novel structure of the bailout – in that it explicitly targets the banking sector without broader budgetary conditions on the government – as a sign that everything euro is flexible and negotiable.