14 Jul June Market Commentary
A result of the recent short term volatility and overall declines in major indices around the world are better valuations and hence improved forecast returns from these lower prices. Overall the shifts have been largely proportional relative to other asset classes.
We are unfortunately in one of those times where a commentary such as this will be out of date by the time it is published, so allow us to present the discussion below about what is happening in Europe with that caveat. Weekend talks between European leaders have broken up without any agreement having been reached as to restructuring the debt owed to European institutions by Greece. In the short term many observers are now assuming that the most likely scenario is that Greece will leave the currency union. In the long term, this episode has once again raised the structural flaws at the heart of the decades’ long attempt to integrate Europe. Whilst this analogy from the Washington Post is descriptive, it most certainly understates the gravity of the situation and not the least of that being the human toll.
“The Greeks, Italians, Spaniards and Irish walk into a bar, where the French and Germans are the bartenders. It’s happy hour, and the Germans and the French are serving half-price drinks. Although everyone quickly drinks too much, the bartenders keep on serving. Eventually, the inebriated customers head home and get into all kinds of trouble — fights, car accidents, some broken windows. So who’s to blame? Clearly, the Greeks shouldn’t have drunk so much. However, the French and Germans also shouldn’t have served the Greeks when they were clearly drunk — especially if the French and Germans mind having broken glass in their neighborhood.”1
As we know the newly elected leader of Greece Alexis Tsipras broke off negotiations in order to hold a referendum last Sunday on whether the Greek people should accept the further austerity required by its creditors at that time. To the surprise of many, including the European technocrats, the result that was returned was a resounding no vote. This however becomes eminently more understandable when you consider the impact that the support from Europe has had on the Greek economy and its people so far.
“To sum up the “success” of Europe’s policies towards Greece, here are a few figures. In early 2010, the Greek unemployment rate was 10.8%; today it is 25.6%. Greek per capita GDP was US$30,700 in 2010 but only US$24,500 today. Debt-to-GDP stood at 129.7% in 2010 but is 180% today – despite a partial debt relief (a so-called haircut) in 2012. To say it in non-technical terms – Europe’s policies towards Greece were a total disaster.”2
The stark reality of the above outcomes, to which the creditors seem oblivious, reminds one of Einstein’s famous definition of insanity. Putting any political persuasion to one side, we have now had six or seven years to observe the impact of imposing austerity measures on already contracting economies, where traditional monetary policy is ineffective at the zero lower bound and extraordinary policy support is clearly required. If the household and business sector are contracting and repairing their balance sheets, then requiring the government sector to also contract leads to only one outcome. A shrinking economy that generates less tax revenue, has more unemployed people that need support and debt levels that continue to grow despite achieving mandated primary budget surpluses. Expecting that more of the same medicine will produce a healthy outcome for Greece, for Europe and the global economy seems to meet the Einstein definition of insanity.
Of all the words written over the last several months about the Greeks and the debt negotiations, these were surely among the most perceptive: “It is difficult to overstate how deeply Europe’s leaders betrayed the ideals of European integration in their handling of the Greek crisis. The first and most fundamental goal of European integration was to blur the lines of national feeling and interest through commerce and interdependence, in order to prevent the fractures along ethno-national lines that made a charnel house of the continent, twice. That is the first thing, the main rule that anyone who claims to represent the European project must abide: We solve problems as Europeans together, not as nations in conflict… These were European problems, not national problems. But they were European problems that festered while the continent’s leaders gloated and took credit for a phantom prosperity. When the levee broke, instead of acknowledging errors and working to address them as a community, Europe’s elites — its politicians and civil servants, its bankers and financiers — deflected the blame in the worst possible way. They turned a systemic problem of financial architecture into a dispute between European nations. They brought back the very ghosts their predecessors spent half a century trying to dispel.”3
In July 2012, the President of the European Central Bank uttered these famous words in a speech he gave in London: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”4 The effect of that speech is difficult to understate, it meant that when assessing the outlook for Europe that what had been a real consideration of disorderly disintegration has largely been discounted for the last three years. Now the possibility of Greece leaving the Euro is perhaps even the most likely outcome, and moreover may well
in time prove to be the better of two bad choices for the Greek people.
Such an outcome will certainly lead to disruptions in Europe and other markets around the world, and the short term fluctuations are not something we try and predict. Rather, we will continue to focus on the improving economic fundamentals and our long term forecasts which indicate that reasonable value is available with a long term view.
On the mainland in China there are two main indices which track equities, one based in Shanghai and the other based in Shenzhen. Both have recorded remarkable rises in relatively short time, as the chart below depicts. Common market parlance describes a pullback of 10% as a correction and a decline of 20% as a bear market. In this case both indices have suffered greater than 20% declines, hence qualifying for the latter description. However, as we have repeated regularly, time frames are critical in assessing market activity, as the New York Times notes “how easy it is to frame market data in a way that sounds either scary or benign, depending on your inclination. ‘The Chinese stock market has dropped 26 percent in a month’ is scary. ‘The Chinese stock market is up 83 percent over the last year’ sounds great. Both are true.”4
From the top we have the Shenzhen Composite in blue and the Shanghai Composite in brown, which together are the Chinese mainland indices. What is clear is how sharp the appreciation was and of course the subsequent decline. All four lines are normalised at a value of 100 starting three years ago, and therefore represent the aggregate return over that period. The black line tracks Hong Kong listed shares, and in purple is the Asia ETF that tracks Chinese and Asian companies, and as you can see it has appreciated relatively steadily over the period for an aggregate gain of better than 60%. We should note that as this is the ASX listed ETF (IAA) which is unhedged against currency moves, so the performance has benefited from our weaker dollar.
Regular readers will know we evaluate the ratio of price to earnings (the P/E ratio) when considering how an index is valued. A price that increases proportionately with a rise in earnings implies the same valuation multiple and this is an observation that largely holds when looking at long time frames. What we know can happen over shorter periods is that for a variety of reasons investors can become more optimistic about the outlook for growth and decide to pay a higher multiple. That appears to be the case with the Shanghai Composite, where the P/E ratio climbed from a steady 10x to 26x and is now back to about 19x, whereas the multiple on the S&P Asia 50 index has ranged between about 10x and 12x.
Next month we will bring the focus closer to home and share with you some analysis of the Australian housing market. This is another example of where scary headlines can be discounted with patient and considered analysis.
1. Ana Swanson. “The forgotten origins of Greece’s crisis will make you think twice about who’s to blame” – Washington Post. 1-Jul-15.
2. Dr Oliver Hartwich. “Greece, from bad to worse” – Portfolio Construction Forum. 10-Jul-15.
3. Steve Randy Waldmann. “Greece” – Interfluidity.com. 4-Jul-15.
4. Neil Irwin. “How to Make Sense of China’s Plummeting Stock Market” – New York Times. 6-Jul-15.
DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management (ABN 33 711 661 027 Corporate Authorised Representative of Paragem Pty Ltd AFSL 297276) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.