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Market Bulletin - Last chance?

22 June 2015

Negotiations between Greece and its creditors reach crisis point as the end of June deadline looms.

Once again, all eyes were on Greece as the “game of chicken” between the country and its creditors continued to be played out. Those were the words of Donald Tusk, president of the European Council, after a meeting of eurozone finance ministers on Thursday failed to cut a deal to unlock €7.2 billion needed by Greece to avoid default on its loans and potential ejection from the single currency.

On Friday the European Central Bank gave Greek banks a cash lifeline by raising the amount of emergency liquidity assistance available by €1.75 billion to allow lenders to pay back depositors, as an estimated €3 billion was pulled out of the country’s banks over the week by anxious savers.

But as the days count down to the 30 June deadline for Greece to repay €1.6 billion to the IMF, Tusk stressed that the “game of chicken needs to end and so does the blame game”. In phone calls on Sunday, Greek Prime Minister Alexis Tsipras briefed German Chancellor Angela Merkel and European Commission president Jean-Claude Juncker on new proposals ahead of an emergency summit of European leaders on Monday evening, which is seen as a last-chance attempt to hammer out a rescue deal. The new plan is understood to involve the elimination of early retirement options, an increase in tax surcharges on higher earners, and a levy on companies with annual income over €500,000.

Commenting on Friday, Stuart Mitchell of S. W. Mitchell Capital was optimistic that a solution would be found, but believed that the failure of the Greek government to live up to its commitments of reform was at the heart of the impasse. “Tsipras has, despite the rhetoric, made no real effort to stand up to the oligarchs or open up the many cartels that hold back the development of the economy. ‘Clientelism’ appears to seep into practically every aspect of Greek life.”

Mitchell believes that the close involvement of Chancellor Merkel will be crucial to a resolution, and stresses that Tsipras does not have the popular mandate to lead his country to an exit. “Recent polls show that some 75% of the population wish to remain within the eurozone.”

The FTSEurofirst 300 Index touched a four-month low during the week but recovered some ground to end the week down 0.9%.

“Decisive evidence”

On Thursday, and as expected, the Federal Reserve left interest rates unchanged, but opened the door for an increase as soon as September, as it expressed cautious optimism for the US economy following the sharp slowdown that struck in the first quarter of the year.

Since the dreary first quarter, which saw the economy shrink by an annualised 0.7%, indicators have started to point to a stronger economy, including higher employment figures, wages, construction spending, vehicle sales, retail sales and consumer sentiment. Yet despite noting the recent uptick in economic activity, Fed chair Janet Yellen stated that the Federal Open Market Committee awaited “more decisive evidence” that the US economy is on the mend before it would raise interest rates.

The interest-rate projections of the Committee signalled that the expected pace of tightening has slowed since its March meeting, with an increased number of policymakers now advocating only one move this year. The Fed is treading a precarious line as it attempts to signal a rate rise while damping the risk of a market tantrum that might derail global growth. Some analysts say any move this year would be premature and choke off the recovery. Among them is the IMF, which recently called for the Fed to wait until 2016.

“We continue to believe that many market participants and policymakers underestimate the strength of the US economy,” observed fund managers Payden & Rygel. “In our judgement, further economic gains to the tune of 2.5–3% annualised GDP growth, continued strong employment and wage gains, and somewhat firmer inflation readings are likely over the balance of this year. The meetings scheduled for July, September, October and December all present viable options for the Fed to shake up monetary policy.”

Investors were reassured that they didn’t have to fear a sharp rise in interest rates and were encouraged by upbeat reports including a lower-than-expected level of jobless claims. The S&P 500 index ended lower on Friday as worries about Greece and a stock bubble in China weighed on the market, but notched its second straight week of gains to end the week up 0.8%.

Elsewhere in the world, China’s stock market had its worst week since 2008 as investors fretted that the country’s world-beating equity rally had run its course. The Shanghai and Shenzhen markets have both more than doubled over the past year, but plunged 13.3% and 12.7% respectively over the week. Japan’s Nikkei 225 Stock Average registered its third-straight weekly fall, declining 1.14%

Short fall

May’s consumer prices figures confirmed that the UK moved out of deflation after just one month. The rise in CPI inflation from –0.1% in April to +0.1% in May mainly reflected a slower pace of food price falls and the recent rebound in petrol prices. Assuming that commodity prices hold steady at their current level, CPI inflation is likely to hover just above zero over the next six months. As Capital Economics observed, it would not therefore take much of a shock for the UK to experience deflation again later this year – for example, it would only take a 10% fall in the oil price from its current level of $62 a barrel. The prospect of inflation remaining well below the MPC’s 2% target throughout 2016 makes it unlikely that the MPC will closely follow the Federal Reserve in changing interest rates. Capital Economics forecasts that UK rates will remain on hold until the second quarter of 2016.

The continued strong recovery in the construction sector helped FTSE 100 plant-hire group Ashtead report record annual profits, up 35% to £490 million, and an increase in dividends of 33%. Ashtead generates 85% of its revenues from Sunbelt Rentals, its US business. Builders are still recovering from the financial crisis and their balance sheets remain under pressure, which means they are still renting construction equipment, from companies such as Ashtead, rather than buying it. Ashtead is “firing on all cylinders”, according to Richard Peirson of AXA Framlington. “Sunbelt continues to grow rapidly and the UK business, A-Plant, is also performing strongly and winning market share.” Peirson forecasts the cyclical upturn in construction activity in the UK and US has some years to run. “We believe Ashtead is a class act and not expensive on about 15x current year earnings.”

The FTSE 100 Index suffered its fourth-straight weekly drop after hitting a five-month low on Thursday as fears over Greece unsettled investors. Despite a small rise on Friday, the benchmark index ended the week down 1.1%.

Pension plunder

Chancellor George Osborne heralded the success of his pension reforms as he reported that 60,000 people had withdrawn over £1 billion from their retirement funds since the introduction of new rules in April. However, it is reported that only around a third of the money was planned for day-to-day living expenses – the original intention of a pension – and that the majority of people had not sought advice to understand the taxation and long-term consequences of their action. In our view, the more appropriate measure of success for the new pension freedoms is whether, years later, those who have withdrawn money are still able to enjoy the retirement they’d planned for.

AXA Framlington, Payden & Rygel and S. W. Mitchell Capital are fund managers for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

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