Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.
Theme 1: Greece needs a debt write-down, one way or another
Greece needs a debt write-down and it can achieve this in an orderly manner (via a deal) or a disorderly manner (via defaulting).
The situation in Greece is fluid, complex and over-reported, so I will try to sum it up with as few words as possible… Tsipras did not get the deal he wanted (debt relief, financial assistance and less austerity) so he put the creditors’ offer to a referendum. With poll results delivering an overwhelming ‘no’, it’s back to the negotiating table to try and get debt relief and a better deal. In short – if no deal is forthcoming, Grexit and default may well be the next step.
Looking at the broader issues, it is worth noting that the Greek economy was doing alright on a cyclical basis last year, however the Tsipras government swiftly changed that. Note graph one below, which shows the initial surge in consumer confidence and then plunge in the Purchasing Manager’s Indicies (PMI). It is a bit of a shame that things have ended up as they are now given they had been making progress; it’s harder to grow your way out of debt when you go back into recession. The other takeout is the debt load in graph two – it is impractically high. Thus debt relief is an essential ingredient to a lasting solution.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream, IMF
Theme 2: North American investor confidence soars
Institutional investor confidence has hit 12 year highs, but it’s mostly North American investors.
The State Street Investor Confidence Index (SSICI) is a measure that indicates whether institutional investors are increasing (readings above 100) or decreasing equity exposure. There are also regional versions of this index however, these regional indices reflect whether institutional investors domiciled in those regions are increasing or decreasing equity exposure in general; they don’t necessarily reflect regional allocations.
There are a couple of standouts – North America domiciled investors are extremely confident, whereas (unsurprisingly) European investors went from very confident to a total loss of confidence. On a global basis, in June the index hit its highest level since May 2003. On that note there has been a clear turn in the multi-year trend of institutional investors becoming less confident, which culminated in the low point of November 2012. We always pay close attention when indicators like this hit extremes, but this index doesn’t really have a consistent record as a contrarian indicator (i.e. higher levels of the index can be consistent with acceleration of the market as well as tops in the market). The takeaway from this is simply that institutional investors are generally very confident – but notably this is driven by North American investors.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream.
Theme 3: US mutual fund flows
US equities are under owned relative to global equities (for reasons that probably make sense).
On a similar topic but this time in the retail flow space, it’s interesting to note the rotation that has occurred in the US mutual fund space (out of US into global). At this point, given the shift in flows and positioning, US equities are out of favour and somewhat under owned. It’s not hard to see why, until recently there have been much better gains available offshore in places like Japan, Europe, and China. Our view has been to underweight the US particularly relative to Europe, as Europe has a better valuation, earnings upside and monetary policy backdrop – the Greece situation does not change that view (it potentially makes it more attractive if the price falls). So this sort of flow and positioning picture is not enough on its own to change the view (from a contrarian perspective), but it is a feature worth noting, as given the right catalyst, these things can unwind quickly.
Theme in pictures
Source: AMP Capital, Bloomberg, Investment Company Institute
Theme 4: Expect action in the China A-share market
The A-share market is in panic mode at the moment. Expect more action by the authorities in an attempt to stabilise the market.
It’s been a wild ride in China A-shares, as the Shanghai Composite rose over 150% from the lows last year to the high on 12 June; and then fell over 25%. It’s difficult to tell whether we are close to a bottom in A-shares – in a market fuelled by liquidity and sentiment, things can turn very quickly. The government has already taken a number of actions: cutting interest rates and reserve requirements, issuing positive propaganda, loosening margin lending requirements, providing window guidance to short sellers, advising pensions to increase equity exposure, pausing initial public offerings, reducing trading fees, etc. There were also some emergency meetings over the weekend which resulted in the symbolic move by major brokers to establish a market stabilisation fund.
One consolation is that while there are many similarities between this bubble and the one that occurred in 2007, when the 2007 bubble burst the People’s Bank of China was tightening monetary policy aggressively. This time around however, it is easing monetary policy. If the crash continues it will probably prompt the authorities to undertake a more sizeable and aggressive stimulus program to stabilise the market and the economy – precarious. Looking at various technical indicators, the market is looking oversold and therefore could easily bounce. That bounce however, may be short-lived as investors sell into it just to get out; a fall of this magnitude and pace can easily shift the mood of the market. It will take something significant to catalyse another leg-up in the market.
Theme in pictures
Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream.
Theme 5: H-shares better than A-shares
H-shares look much better than A-shares and are more likely to benefit if the Chinese economy improves and the Greek situation is resolved.
China H-Shares have also undertaken a correction (falling about 15% from the top), but while the picture is quite murky for A-Shares, it is quite positive for H-Shares. H-share valuations are more favourable in comparison to their own history and in comparison to A-shares. Additionally, H-shares trade quite differently to A-shares on two fronts; firstly they trade more in line with the macroeconomic currents in China (which appear to be stabilising) and secondly, they trade more in line with the global equity risk regime (supressed at this point by Greece risk). As the macro picture appears to be stabilising thanks to the long list of stimulus measures announced and implemented in China (and thanks also to the rebound in the property market), one short-term headwind could be set to turn to a tailwind for China H-shares; at the same time some form of resolution to the Greece debt crisis could also be quite positive.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream, Bloomberg