John Husselbee, Liontrust
Following the election of the Syriza party at the start of 2015, Greek efforts to renegotiate the terms of its economic bailout garnered ever more attention. The talks between the country and its creditors were seemingly interminable and saw multiple deadlines pass without any agreement reached on how its liabilities would be funded in future. Despite the column inches devoted to the issue, investors largely saw the negotiations as a sideshow, even when in July, 60% of the Greek people rejected the terms of a new bailout package that had been proposed. Somewhat surprisingly, having received a strong mandate to continue a belligerent approach to negotiations, Greek PM Alexis Tsipras a few days later backed down on most of the sticking points when submitting economic reform plans which were more to the liking of its creditors.
At the same time as the risk of Greek default and potential exit (or ‘Grexit’) from the Eurozone was diminishing, concerns were growing over the path of economic slowdown in China and the level of volatility in its stockmarkets. In contrast to the market’s apathy towards Greece’s travails, the worries surrounding China did cause some disquiet; global equity markets rolled over from their highs, while Asian equity market volatility spiked. Chinese equities had previously rallied substantially into what many deemed bubble territory before relinquishing chunks of their gains. Chinese authorities have been attempting to manage a slowdown in the economy towards a ‘new normal’ of ‘around 7%’ growth at the same time as avoiding instability in its stockmarkets. Despite significant and, in the eyes of most international investors, unwelcome efforts to create artificial stockmarket stability, Chinese equity markets nevertheless continued to experience volatility. When the authorities decided to devalue the yuan, this ushered in a new wave of negative sentiment, causing Chinese markets to plummet, and pulling global equity markets into a full-blown correction. The currency depreciation, which traditionally boosts exports, has been interpreted by some as a signal that Chinese policymakers are more concerned about the pace of economic growth than they are willing to let on.
We saw the Grexit saga as a slight red herring in terms of its potential economic impact and we believe that the Chinese sell-off is simply the most recent of a number of “risk-off” episodes which have hit markets since the Global Financial Crisis, although we acknowledge that investor sentiment may take some time to recover on this occasion. We are long term investors rather than traders. To put it another way, we would rather have a courtship of financial markets than an evening of speed dating. We have therefore been focusing on the event which we think will be the most influential driver of asset price moves in the longer term: an interest rate rise in the US. Where appropriate we have therefore used the recent market volatility relating to Greece or China as a chance to further position ourselves for a rising US rate environment.
We have been preparing for higher interest rates – in the US and UK initially – for some time now. As central banks ‘normalise’ their rates, we expect bond yields to rise (which means declining capital values). Many government bonds yield less than the long-term average rate of inflation meaning that buyers at current levels may well be signing up for negative real interest rates (i.e. inflation will offset the interest payments they receive). After several years of near-zero rates, the disparity between very high bond valuations (with correspondingly low yields) and economic reality could be thrown into harsh contrast when central bank rates start to rise.
When a US rate rise does occur, we also think that emerging market equities may offer up good long-term entry points. Higher US rates may mean a stronger dollar in the short term, which could see some money flowing away from emerging markets and back to the US. But the long-term implications of a strong US economy for emerging market growth are very positive.
In summary, there is currently no cause for panic: the global economy continues to grow modestly with most leading indicators in the US and Europe suggesting further expansion, and this is compensating for weakness in China and other emerging markets. The potential for contagion from Chinese financial markets into the developed world real economy is in our view far less than the market sell-off has suggested. Central banks are providing supportive policy in Europe and Japan, China is acting to stimulate its economy and the US will not raise rates without evidence of economic resilience.
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