Lost in translation

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We keep hearing of the term ‘global market place’. At a time when the fabric of the EU is being tested by the prospect of a Greek debt default, it is perhaps worth remembering the ability to trade freely in a ‘common market’ was one of the original pillars of the European Union. Globalisation is changing the way business is being done. The EU is the largest economy in the world, along with being the biggest exporter and importer.

Which got us thinking. The OECD has forecast that by 2030, Asia could have 66% of the world’s middle class, compared to 28% in 2009. Specifically it was reported last week that China has a surfeit of savings – estimated at $21 trillion! This could create enormous demand for a range of companies involved in producing luxury consumer goods and cars to the providers of banking services and life assurance as well as leisure and holiday operators. In future, perhaps every day instructions will need to read Made for China rather than Made in China.

This could become a much more familiar sight 請按照指示 *

When markets are experiencing short-term volatility, it helps to remember some of the long-term positive trends which should benefit equity investors. Although, this week, perhaps the above warning is more relevant.

What have we been watching?

The €7.2bn Euro question! At the time of writing it would appear unlikely that Greece will be able to make its £1.5bn IMF payment due tomorrow. Assuming the payment is not made, it is uncertain whether this will be consider a default to the IMF only, a cross default to all creditors or simply be ‘in arrears’.

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While Greece is officially on national holiday, it is proving a giant headache for investors. Default is a concern for the longer-term stability of the Eurozone. Given the number of countries within Europe with growing anti-establishment parties then markets could become increasingly nervous in the future should one of these come into power or a position of influence. France, Italy and Spain come to mind, and the latter has an election at the end of this year.

Regardless of whether Greece and its creditors do or don’t agree a last minute deal, its banking sector is still in a mess. The ECB has had to provide enormous sums of liquidity to the Greek bank sector while bail out talks have dragged on. It is estimated over €120bn has been used to support the Greek banking system. It is notable that in other European countries where we have seen a previous financial crisis – UK, Ireland and Spain, recovery has only been achieved with a recapitalisation of the banking system. Given it is estimated that over 40% of existing loans by Greek debts need be to written off, then, even if there is yet another short-term fix between the EU and Greece, the banking system is likely to continue to act as a drag on economic recovery. If Greece were to fall out of the EU, it is unlikely the ECB will be repaid by local bank liquidators. The potential loses that the ECB is exposed to, are close to its entire capital base. Recapitalisation will no doubt be required.

Ironically, aside from Greece there appears to be a wider recovery within the EU. The flash Eurozone PMI manufacturing reading for June remained in expansion mode, as did the services reading with both ahead of market expectation.

However, European geo-political issues were back on the radar screen. The US defence secretary said that the USA would store tanks and weapons across Eastern Europe to deter Russia. While not a return to the days of the Cold War, it certainly appears to be getting frosty.

In the UK, one of the MPC’s most hawkish members suggested that the BoE should consider raising interest rates as early as August, highlighting rising wages and low unemployment. George Osborne will deliver his first Budget of the new government on the 8th of July and has already indicated that he will focus on raising productivity in mid-sized businesses.

The US also saw comments on interest rate policy. Fed Governor Powell said that he is currently forecasting two rate hikes in 2015, in line with recent Fed comments but that a December move is looking more uncertain. Despite talk of rate hikes, like the UK, housing remains a bright spot with new home sales jumping to a seven year high. Again, as in the UK, a buoyant housing market is increasing consumer confidence. US consumer spending in May saw the strongest growth in almost six years.

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Japanese manufacturing activity contracted slightly in June as new orders fell and output growth slowed, but new export orders saw the fastest expansion in four months.

Following a well-documented bull run, Chinese shares have recently nosedived and now stand 20% lower than their June 12 peak. The economy has been in deflation with producer prices falling for the last three years according to HSBC economists. This is helping to mask a significantly worse economic slowdown than official data suggests. While growth was expected to slow due to reforms, underlying growth might be under 6% compared to the official GDP growth target of around 7%. HSBC flash PMI data revealed manufacturing remained in contraction for the fourth month in a row. Chinese authorities, appear committed to supporting the economy and over the weekend cut benchmark rates to a record low.

And finally, it is easy to be drawn into the debacle that is Greece and focus on Europe’s woes but it is worth watching the bigger global picture. As highlighted earlier, China remains a key ingredient in global growth these days. The price of copper for three-month forward delivery has recently dropped to below $5,700 a tonne, close to levels seen in the last financial crisis. One of the reasons cited is that demand from China’s State Grid Corp, the world’s largest utility, has fallen below expectation, having been caught up in the country’s anti-corruption drive. The Chinese officials have allegedly misappropriated about $1bn in 2013 during work on China’s west-to-east electricity grid.

Lost in translation

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