Category: 2015

As we approach the June Solstice in the northern hemisphere, we would do well to remember that in Greece and North America at this time of year it is known as the longest day of the year. The Latin from which the name is derived is “Solstitium” which means nothing less than “sun-stopping”. So, as we approach the final chapter in a farcical end game between Greece and the IMF/EU/ECB/EFSM/EC/European-taxpayers/(insert acronym beginning with “E”), we truly are about to finally watch the sun stop shining on Greece’s financial credibility. Again.

 

Angela Merkel, the Chancellor of Germany, now finds herself pulled into political discourse due to her to date unbridled support of expending all possible efforts to extend to Greece the means to avoid default. The way political parties have to share power to govern in Germany is in fact quite similar to in Greece. Merkel’s Christian Democratic Union party (centre-right) could not hold power in its own right. Neither can Tsipras’ communist-principled party, Syriza. Merkel shares, indeed owes, her power with the Christian Social Union party (centre-left). In this party coalition, Wolfgang Schauble ranks second only to Merkel and in return for his allegiance and willingness to work with a coalition, holds the post of Minister for Finance in “Merkel’s” government. In recent weeks there have been noticeable fractures between both Merkel and Schauble, with Merkel wanting to be more lenient towards Greece in order to reach a deal, and Schauble wanting Greece to pay what owes or leave the EU. In Greece, the other parties Syriza shares power with in order to govern have approached Tsipras’ tin ear, begging him to not risk Greece’s inclusion in the EU and the Euro currency.

 

Tsipras’ own political judgement is observably sub-optimal. This is a man who joined the Stalinist Greek Communist Party in 1991. That year, he would have received his membership card just in time to watch the Soviet Union finally come to the conclusion that after around 50 years of communism, it didn’t really seem to be working for the people. The government’s fiscal affairs were poorly run and essentially broke, so they discarded the communist model and became the Russian Federation. At Tsipras’ right hand as Finance Minister sits another self-avowed communist who, despite being an academic and having authored a book on game-theory, doesn’t seem to have made the transition to the big leagues known as “the real world” particularly well at all.

 

The IMF will come calling by June 30 for EUR1.5 billion. Then, in a mere matter of weeks, the total bill owed to creditors will reach EUR7.2 billion. Should Greece even miss the EUR1.5 billion payment to the IMF (which they will) then they will find themselves in the esteemed “ZZZ” rated class of Zaire, Zambia and Zimbabwe. You couldn’t make this stuff up even if you tried to. No “developed” country has ever before in history missed a repayment to the IMF. This of course speaks to the heart of the matter. Why was Greece ever allowed to rank as AAA rated (their debt was as good as German debt) when they, now proven to be fraudulently, entered the EU? As Wolfgang Schauble said in 2012, when the Europeans were asked to provide another EUR130 billion, “Why do they deserve another 130 when 100 two years earlier [sic.] had proved insufficient”. Wolfgang’s comments embody the argument that you simply cannot have a political union without fiscal union within the European Union.

 

So what happens next globally after Greek defaults? Do we get to see a repeat of 2011 when other nations in the periphery fall under the same spell of sovereign contagion as Greece’s debt markets? Do we get a return to the blowout in sovereign spreads for Spain, Italy and Portugal in the region of 640 bps over German Bunds? Bunds have, at certain maturities, only just re-entered positive yield territory again in the past 4 weeks.

 

Materially speaking, Greece is of course immaterial. This is applicable to both the operations of the EU should Greece depart and also global financial markets. Apologies to those of Hellenic descent, but Greece’s USD$241 billion GDP contribution per annum to EU’s USD$17.3 Trillion GDP is only 1.3%, which therefore represents 0.047% of the USD$509 Trillion of global GDP. To put this in perspective though, as the World Bank tells us, Greece’s economy is still larger than Kazakhstan, Azerbiajan or Uzbekistan. The Greece FTSE Large Cap index has lost 50.8% in the last 12 months since June 2014. The FTSE/AThex Large Cap index had a combined value at time of writing of USD$38.1 billion as at 19 June 2015. To put this in perspective, the single stock Australian and New Zealand Bank has a market cap of (in comparable USD terms) of USD$70.2 billion.

 

Greece will, as sure the sun sets, default on its debt. This will hardly be a trailblazing event when it comes to Greek financial history. The current Greek administration needs to cease and desist pursuing academic games and embrace mathematical reality. The question that Tsipras and his comrades should start devoting their time and attention to is whether, once the default occurs, do they choose to remain in the EU, and if so, on which currency. After they have made this decision (if they stay, they should no longer expect any sweetheart funding subsidy deals from the Germans, Scandinavian states or any other member state of the EU whose population pay taxes) then they need to decide if they stay on the Euro currency, or revert to the Drachma. Again.

 

The smart play here would be to promptly default, put global financial markets out of their misery and beg humbly to stay in the European Union, whilst exiting the European Area (countries in the EU that trade on the Euro) and revert to the Drachma.

 

The summer solstice marks the start of summer. This may bring short-lived joy because only a few months later this means that winter will follow. With the European grand project called the “EU”, we are concerned that a “successful” resolution to a Greek default may disprove the old notion that it is darkest before the dawn.

 

The largest stock by market cap on the Greek exchange is “Coca-Cola” and its weighting constitutes 54% of the entire index (ref. Athens Exchange Group). The sixth largest stock by market cap is the “Greek Organisation of Football Prognostics”. Syriza’s leader, Alex Tsipras rides a motorbike with a symbol that shares the colours of the Greek flag, but is made by a Motor Works company in Bavaria. This is and always has been (since 2011) an issue of political ideology vs material impact. Everyone wants the finer things in life, but if you buy them with borrowed money, one day you must pay the piper.

 

References:

The Athex Exchange Group

Factset

The Financial Times

The World Bank

 

Marcel von Pfyffer

Q.E.D.

Winter has come. A bitter winter can bring with it devastating effects and not just for Al Gore. Winter will kill crops, defeat armies and in some countries where snow falls, it will hide the green grass under a blanket of white for an entire season. Only when the season changes and the snow melts away will the grass appear greener than ever to those who look upon it.

 

Winter in the US this year (2015) has affected US first quarter GDP numbers in a very similar fashion as to what they did to first quarter GDP numbers last year (2014). Alongside this, we see many market participants voice continued concern over the level of valuation for US equities. Another distraction coming to market is that some market participants are questioning whether the equities market’s ascent is due to earnings growth or simply share buy backs. There is a veritable buffet of reasons, were one that way inclined, to believe that US equities have hit their peak.

 

The first quarter GDP numbers in 2014 painted a dismal picture for calendar 2014 in the US. Remember that in 2013, the US economy delivered a below trend annual GDP rate of 2.2%, so the Fed expectations going into 2014 were markedly higher, given the expected uplift that the pledged continuation of QE was supposed to contribute. The winter of Christmas 2013 going into January 2014 was particularly bitter across the US leading to an advanced estimate of first quarter GDP being a barely positive +0.1% (% change from 1^st quarter 2013 to 1^st quarter 2014). This “advanced estimate” which is allegedly seasonally adjusted was revised further downwards on May 29^th 2014 to -1.0%. By the year’s end however, US annual GDP was found to have grown +2.4% through calendar 2014.

 

Come Christmas 2014 and going into January 2015, the US was again beset by yet another bitter winter and on top of this was forced to endure severe labour market “action”, which saw many East Coast ports shut down due to strike action. As the data would show, this would eventually blow the trade deficit out by a massive 8% change at the end of the first quarter. In regards to GDP, clearly when ports are shut down if not by winter, by strikes, then it is quite difficult to export goods which would have otherwise contributed to GDP numbers. Hence, when presented with 2015’s 1^st quarter GDP number being +0.2% (a very similar number to 2014’s) some market participants are concerned that this will herald a slower 2015 than the US Federal Reserve forward projections would otherwise have us believe.

 

The problem here with the inaccuracy of the 1^st quarter GDP numbers’ bearing on actual economic activity for the other 3 quarters of the year have been cause of much debate. “Seasonal adjustment” of the numbers is supposed to remove noise or volatility from the data due to holidays, weather and lost productivity often associated with Christmas and the winter period. However, 1^st quarter GDP has been shown to average 1.6% lower than other quarters across the last 20 years. If this can be observed with regular effect, then theoretically seasonal adjustment should be “taking care of” what the human eye can do to a column of quarterly spreadsheet data.

 

The US Federal Reserve Bank of San Francisco by its own admission states that, “Of course, seasonal adjustment is an imprecise and uncertain statistical exercise”. This should make hedge fund managers throw their toys out of the sandpit in pure exasperation when they are using such data to attempt to make multi-billion dollar investment decisions based on the direction that the nation’s statistical body, the Bureau of Economic Analysis, is leading them.

 

 

Why is all of this so important? Without a clear read on “proper” US GDP, the market will not be able to accurately forecast (yes, an oxymoron!) what Dr Janet Yellen’s decision may be regarding the timing of a rate rise. The market has moved earlier this year from an almost unanimous decision that the Fed would raise rates in June 2015 to a possible rate rise by the end of 2015. Despite continual performance of US corporate debt markets (or perhaps because of them), investors are even more so concerned about the timing and pace of US interest rate rises. If the economy is not recovering, then the Fed will not raise rates quickly or possibly at all. If it does raise rates, what effect will that have on the wider economy? If the wider economy suffers due to an interest burden imposed by an impatient (or overly patient) Fed, then will there be any corporate profits to distribute?

 

People suggesting that relying on revised US GDP estimates this time round (2015) to be different may want to take a look at the data set. Although it is almost taken as gospel that the most amazing growth period the US ever experienced was through the Great Moderation of the last 30 years, this is simply not the case. Since 1930, average annual US GDP has been 3.4% (all data presented here is in chained 2009 dollars). Since 1964, the average annual GDP number in the US has been 3.0%. In the Great Moderation of the last 30 years, it has been 2.8%. This gives pause to the thought that the US economy may not be able to deal with an environment of rising interest rates. To be sure, a heightened interest rate environment will affect some industries and companies within the US economy, but if their business is only sustainable in a near-zero interest rate environment, then the question must be asked, was their business model ever really sustainable?

 

During the tenure of Paul Volcker at the Head of the US Federal Reserve (1979-1987) and across the Regan administration which saw off stagflation, US GDP annually averaged…wait for it…3.0%. This was at a time when Volcker raised the US Federal Funds rate from low double digits (!!) in the late 1970s to a monthly peak of 19.1% in June 1981 (US Federal Reserve FRB_H15).

 

Mark Twain once said that “History does not repeat itself, but it does rhyme”. Well, during Volcker’s reign from 1979 to 1987, the stock market only had 2 years where it finished in negative territory. Clearly 1987 was one of those two years. So, a return of 147% in US equities across 9 years implies an average annual (but not compounded) return of 16.3%. Not bad for a period where interest rates averaged double digits. However, for the stock market to be firing, so too must the broader economy.

 

By the end of May (29^th), time – or the Bureau of Economic Analysis – will have told.

Marcel von Pfyffer

Q.E.D.