Download Macro-economic environment - February 2015

INVESTMENT
NEWSLETTER
MONTHLY REPORT
FEBRUARY 2015
MACROECONOMIC
ENVIRONMENT
Much analysis has been done on this topic. What
has been found is that from 1950 to 1984, years
where the month of January saw a positive return
were predictive of a positive return for the entire
market with approximately 90% probability. In
the opposite case, years with a negative return in
January were predictive of a negative return for
the year approximately 70% of the time.
There is a theory in the financial markets which
is known as the “January effect”. This theory suggests that there is a seasonal anomaly where stock
prices increase in January more than in any other
month. In a similar vein , there is another saying
which states “As January goes, so goes the year”.
This is also known as the “January barometer”
and it suggests that if the month of January is a
positive month then the year will also be positive,
and vice-versa of course.
Looking at equity markets during January 2015
(see chart below), if the latter theory comes true,
then we are perhaps in for a positive year in Europe
and maybe the emerging markets but the USA will
lag. However, looking closer at the strong performance of the European equity markets in January,
investors should also perhaps be aware that it is
very unlikely that this trend can continue without
a correction at some point.
Chart 1
Source: Bloomberg.
MSCI equity market indices for January 2015.
The first month of 2015 was also packed with a
series of political and economic events which
added to an increase in volatility. The main focus
of attention was on the European Central Bank
(ECB) monetary policy meeting of the 22nd. It was
already a generally accepted fact that the ECB would
announce some form of quantitative easing (QE)
programme but the size and format of this QE intervention was open to much speculation. Following
that there would be the Greek elections on January
25th and with that the possibility of Greece exiting
the Eurozone. Finally, if that wasn’t already enough,
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the US central bank (the Fed) was scheduled to
meet on January 27th/28th.
However, in the days leading up to the ECB meeting, the Swiss National Bank (SNB) surprised the
markets on January 15th by declaring that it would
no longer peg its currency at a level of 1.20 versus
the euro. The QE which would almost certainly be
launched the following week by the ECB would also
probably lead to a depreciation of the euro and so,
mechanically, lead to an appreciation of the CHF.
It would be difficult and expensive for the SNB to
stand in the way of such a market move. Therefore
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in anticipation of the ECB’s action, the SNB decided
to abandon the currency peg. At the same time
the SNB lowered the interest rate for deposits
to -0.75% from -0.25%, as a way of discouraging
further currency inflows. The immediate impact
on the foreign exchange rate was swift and violent,
the €/CHF rate plummeted from 1.20 to around
0.96. The Swiss equity market index closed down
-8.67% on the 15th and also lost a further -5.96%
on the 16th. As we reached the end of the month,
the EUR/CHF rate had recovered slightly to around
1.05 and the equity market had rebounded about
6% from its January 16th low point.
already very low and bank liquidity is abundant
opens the door to the question of what is the utility
of additional monetary creation in the current
environment? On the other hand, not implementing
QE would have led to a drastic deterioration in the
financial markets that the ECB could not afford to
trigger. The ECB’s QE announcement was historic
but it was also the central bank’s final trump card.
The ECB can buy time for Europe’s policy makers
but this cannot continue indefinitely. Europe’s politicians are relying too much on monetary policy
instead of taking the painful steps to restructure
labour markets and improve competitiveness.
As expected, on January 22nd the ECB finally entered
the global QE arena. Instead of keeping some aces
up its sleeves, the ECB decided to play its full hand
all at once and announced a QE programme that
was bolder than expected. The arguments supporting this QE decision had already been known
for some time; low inflation expectations, negative
inflation rates, a bleak outlook for growth and
disappointing results from earlier liquidity measures. With the launch of this programme, the ECB
was announcing that additional asset purchases
are necessary to counter the weaker than expected
inflation dynamics and the heightened risks of a
prolonged period of low inflation. In more detail,
the ECB announced an expansion of the current
asset purchase programme to include government
bonds and supranational bonds. The ECB purchases
will be limited to 33% of each issuer and 25% per
issue. The programme will start in March and the
aggregate size of the monthly purchases will be
Euro 60 billion. The ECB intends to pursue this programme until at least September 2016 or until the
path of Eurozone inflation is consistent with the
ECB’s inflation objective of below, but close to, 2%.
Next up on the January event list was the Greek
elections. As had been widely predicted by the
opinion polls, the anti-austerity party Syriza was
the clear winner but they fell short of gaining an
outright majority. Less than 24 hours after winning
the election, the head of the far-left Syriza party,
Alexis Tsipras, was being sworn in as prime minister having formed a coalition with the center right
Independent Greeks.
The impact of QE in the Eurozone is highly controversial. There is no guarantee that QE will work.
Mario Draghi’s goal is to convince investors that he
has a strategy big and bold enough to reinvigorate
a depressed economy. Whether ECB purchases of
government bonds will free up new lending space at
banks is far from certain. The ECB can prepare the
ground for more investment activity but it cannot
force consumers to spend or companies to invest.
This also requires structural reforms and fiscal
support. Introducing QE at a time when financial
asset prices are high, long term interest rates are
In some respects the country is in better shape than
in the summer of 2012. Growth of 0.7% in the 3Q of
2014 put Greece among the best performers of the
euro zone. The public finances are also healthier
than in 2012, thanks to the same austerity that Mr.
Tsipras so detests. However, regardless of these
improvements, the Greek economy remains fragile.
Syriza and its supporters contest the terms of the
bail-outs but Greece remains dependent on official
support. The European bail out which was due to
end last year has been extended to February 28th.
Syriza rose to power after campaigning to cast
aside austerity, backtrack on reforms and insist
that Greece’s vast debt mountain be slashed. These
promises won votes for the party but they also
spooked investors. The Greek stock market slumped and Greek banks suffered their biggest one
day drop ever on January 28th. Syriza’s pledges are
also unacceptable to other European governments
and the one that matters most is Germany. Could
the clash lead to the result that everyone feared
back in 2012: the “Grexit”, or Greece’s exit from the
Eurozone. Mr. Tsipras insists that his country will
stay in the euro and this policy is also backed by
3
/4 of the Greek public.
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The probability of Syriza securing a formal write-off
of some of Greece’s foreign debt (which totals a
massive 175% of annual economic output) is very
unlikely, particularly as the German government
is strongly opposed to such a deal. A compromise
is more likely, in which the creditors extend the
maturities of Greece’s debt payments and offer
lower interest rates (or even perhaps an interest
rate moratorium). The problem is that Greece has
already benefitted from such concessions in the
past. More such gestures would not radically transform Greece’s economic outlook for the better.
At the time of writing, there was perhaps some hint
of a softer stance from Mr. Tsiparas who stated
he was confident “we will soon manage to reach
a mutually beneficial agreement, both for Greece
and Europe as a whole”. He also said he was not
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“seeking conflict”. The fact that Lazard Bank had
been hired to advise on Greece’s debt burden is an
indication that developments are moving quickly.
Politics will pose a big threat to the Eurozone over
the years ahead and how the Greek situation is
handled might have big consequences elsewhere.
We have already seen in Spain how thousands
of people attended a rally for the leftist party
Podemos.
There is another saying which goes “beware of
Greeks bearing gifts”. Perhaps in the current environment, we could change it to “beware of Greeks
voting for gifts” ?
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