What a Grexit Could Mean to Investors

Transcription

1 7 Volume 7, Issue 7 Allianz Global Investors Insights July 2015 Global View What a Grexit Could Mean to Investors In recent weeks, we have been assessing our investment stance given rising concerns over Greece and the possibility of a Grexit from the euro or possibly even the European Union (EU). As the crisis continues to unfold, we expect more volatility in all European asset markets in anticipation of the newly announced referendum on Sunday, 5 July. While we anticipate a pronounced risk-off environment, we do not foresee disorderly markets. Indeed, from a macro and capital markets perspective, we see the risk as being containable and therefore view the downside volatility as a potential buying opportunity. How our view of the crisis has evolved The turmoil in Greece began in 2010, which led to the first EU and International Monetary Fund (IMF) bailout, socialising many of the banking loans that had been extended to Greece. Those developments, together with the European Central Bank s (ECB) whatever it takes commitments in the summer of 2012, led to our previous position that a Grexit was very unlikely. This belief was founded upon the existence of a credible austerity and economic restructuring package that would restore Greece to health, along with strong political support that would keep Greece in the EU and the euro. We were mindful that the austerity imposed by subsequent governments was extreme, yet we believed additional aid would be forthcoming in recognition of progress made. Indeed, until recently, Greece s economy had been stabilising, albeit at great social cost, and had a growing fiscal surplus. However, the election of Syriza, with its clear anti-austerity mandate, was an obvious cry for help from the Greek people, for whom the last five years have taken a terrible toll. The subsequent negotiations between Syriza and the EU have at times resembled game theory in action, yet we believed that a resolution Andreas Utermann Global Chief Investment Officer would be found once the situation became sufficiently grave as had happened in earlier crises with Greece and Cyprus. Instead, negotiations deteriorated badly, and there has been a breakdown of trust between all parties. Over the past week we have seen news flow in both directions. There were more encouraging signs of a convergence of views, which had fuelled hopes of another deal even if it were yet another postponement to (Cont. on page 2) 03 Viewpoint Corporate Reform Should Spark Japanese Equities 04 Soundbites from Research M&A Activity Is Boosting Semiconductor Stocks 04 Perspective on Europe Great Rotation Has Mileage in Europe 05 Heard at AllianzGI An Underappreciated Link Between Oil Price and EUR/USD

2 Allianz Global Investors Insights Global View the debt forgiveness that Greece may ultimately need. Yet the twin key themes of austerity and its efficient execution against significant debt forgiveness continue to be repeated by both sides to their mutual exasperation. Even as we now have lower confidence in a constructive outcome, our conclusion is that a Grexit, should it occur, may take over a year and will only succeed through negotiation. This intriguing scenario offers up the prospect of a constructive period of engagement, after the headline shock, between the Greeks and the EU, which may well create buying opportunities. Sources of a possible Graccident In the coming weeks, there are a number of key dates at which the Greek debt issue can escalate or be resolved including the 30 June repayment of EUR 1.5 billion to the IMF, the 5 July referendum, the 10 July maturation of a EUR 2 billion Treasury bill and the 20 July maturation of EUR 3.5 billion in ECB loans. Perhaps the most critical of these dates is the 5 July referendum, when the Greek people will vote on their country s next decisive step. Until the markets learn the outcome, our fears of Greek banking sector woes and Greek banks potential insolvency will be tested. The ECB s recent decision to maintain emergency liquidity assistance at EUR 89 billion in essence means that Greek banks remain solvent, but it put those banks in a difficult position in terms of meeting withdrawals. As such, capital controls have now been introduced, which will clearly have serious consequences for the Greek economy. In terms of the loans that are maturing over the next few weeks, it is also important to note that non-payment of bonds would not be viewed by the credit rating agencies as an immediate default, which would allow all parties more time to find an acceptable solution. The road to an actual Grexit Our understanding is that exit from the EU or the euro is by negotiation only the Maastricht and Lisbon treaties did not conceive nations ever leaving and we believe these negotiations could last over a year, possibly two. During this time, Greece would be in a kind of purgatory with a range of good and negative possible outcomes: Good Greece and the EU could find a new way forward, which we believe remains quite likely because Greeks are both proeuro zone and pro-eu. Moreover, Greece is part of NATO, and the US will encourage a solution that lessens any further geopolitical threats from Russia. Negative Trust between Greece and the EU could be fatally broken, raising tensions that could flare up in Spain s 2015 elections and France s 2017 elections. Greece could rotate toward Russia, thus endangering the southeastern flank of NATO at a time of concern over Ukraine and Syria/Islamic State. But even if a Grexit occurs, it could unite the rest of the EU and euro zone and push them closer to a United States of Europe a positive development indeed. Probable impact on markets Obviously, while the ECB s quantitative easing program and outright monetary transactions (OMT) will temper much bond and currency volatility, a black swan event remains a possibility. All investors are primed to be alert during this period of volatility and newsflow. Fixed income The Greek crisis is creating a sense of déjà vu, triggering the same effects experienced during earlier episodes of the euro government bond debt crisis: wider credit and peripheral spreads, higher volatility and a flight to quality on German bunds. Every negative headline should reinforce these trends. Yet for peripheral bonds and credit, there is more to gain here in the medium term from buying on dips rather than selling on rebound. Equities The threat of nationalisation is highest in Greek banks. Contagion to other areas, especially in the peripheral countries, is likely to be correlated with moves in fixed-income markets, the widening of spreads and banks exposures to sovereign debt. Yet again, for those focused on the medium term, we expect volatility and market depreciation to create buying opportunities. Currency We expect the euro to remain both volatile and weak during this period, supported by the ECB s policies and by the recent trading range of 1.05 to 1.15 to the US dollar which has not been broken during this recent escalation of tensions. Any further weakening in the event of a Grexit or Graccident is likely to be shortlived. 2

3 Viewpoint Corporate Reform Should Spark Japanese Equities Allianz Global Investors Insights Japanese equity markets have posted decent returns this year, as evidenced by the Nikkei 225 index, which is up by mid-double-digit percentages in US dollar (USD) terms. In step with these returns, the Japanese yen (JPY) value of the Tokyo Stock Exchange First Section, which comprises about 1,900 of Japan s biggest companies, has exceeded the previous record JPY value set in December 1989, when the country s economy was at the peak of a major stock and land-price bubble. The Bank of Japan (BOJ) has been helping support the equity markets by purchasing exchange-traded equity funds at an annual pace of JPY 3 trillion since October In addition, government pension funds have increased their exposure to equities and helped stabilize Japanese equity markets. The BOJ is determined to stick to its assetpurchase plans that total JPY 80 trillion per year, an amount that is equivalent to 16 per cent of Japan s economy. There is still likelihood that the BOJ will undertake more monetary easing to achieve its 2 per cent inflation target, as Japan s consumer price index has recently dropped to 0 per cent again. The view on the JPY is still pretty bearish, as most analysts argue that the fundamentals are pressing for a weaker JPY. However, the JPY has lost more than a third of its value since its 2010 peak of JPY 75 to the USD. Despite the JPY s decline, Japan s outward investments are strong, and outward mergers and acquisitions are nearing record levels. Public pension fund managers are increasing their exposure to foreign assets as they tilt their portfolios toward greater risk. Real Japan gross domestic product (GDP) for the first quarter grew by an annualized 2.4 per cent a rather upbeat number that masked a surprise build-up in inventories during the period. Real wages have also fallen for almost two years through March While real wages are widely expected to climb this year, the pace appears to be modest. Nevertheless, the household and business sectors showed some recoveries in the first quarter. Spending by households rose, exports continued to rebound and capital spending edged up for the first time in four quarters. Several major corporations have even moved some production back to Japan, as the weakness in the JPY makes domestically produced goods more competitive. Japanese companies have reported strong profits, thanks partly to a weaker JPY that fattened earnings of larger exporters. However, many non-manufacturing companies were hit by both the weaker JPY which has inflated the costs of imported raw materials and a decline in consumer demand after Japan raised its sales tax in April From a market perspective, since Prime Minister Shinzo Abe s government introduced pro-growth and pro-market policies in December 2012, Japan s most important structural reforms so far have been its corporate governance reforms, which are scheduled to be implemented in the latter part of The addition of independent Raymond Chan CIO Equity Asia Pacific directors should increase the chance that corporate managers are more focused on shareholder returns, and create pressure to return cash to shareholders. But the real reason to be positive on Japan is not to argue whether Abenomics will succeed in consistently generating real GDP growth; rather, it is the belief that genuine reforms are taking place on the corporate side. This development should continue to support the Japanese equity markets in the near to medium term, especially given that valuations are attractive. Source for all data: Allianz Global Investors as at 5 June

4 Allianz Global Investors Insights Soundbites from Research M&A Activity Is Boosting Semiconductor Stocks Merger and acquisition (M&A) activity in the semiconductor industry has picked up meaningfully during the last several years, to the benefit of shareholders of both the acquired and the acquirer companies. Unlike the typical M&A transactions of years past which were primarily focused on adding capabilities to drive revenue growth, and were generally unsuccessful today s deals are focused more on achieving scale to drive higher earnings and cash flow, and they re producing strong stock performance. A key factor driving industry consolidation in the pursuit of scale is the increasing cost of manufacturing, which has risen materially for digital devices such as application processors, memory and mixed-signal integrated circuits. From the mid-1990s through the mid-2000s, the barriers to entry in the semiconductor industry were relatively low thanks to low-cost manufacturing from outsourced foundry suppliers. But in recent years, few new semiconductor companies have been launched due to escalating manufacturing costs requiring larger revenue scale. Moreover, many of these fabless companies have struggled and are seeking a strategic alternative through a sale or merger with other players. Another factor powering M&A activity is China, which is pursuing the development of its semiconductor industry through acquisitions; its government has announced plans to spend USD 160 billion over the next ten years to jumpstart this industry. Indeed, China has already used several professionally managed investment funds to acquire and form strategic partnerships to gain access to certain intellectual properties. We fully anticipate more consolidation and mergers of equals in the coming years, given James Chen, CFA Senior Research Analyst that so many companies remain sub-scale. In addition, we expect to see product lines being streamlined as acquirer companies rationalize their portfolios to achieve greater cost synergies. In our view, this M&A wave is yet another positive investment catalyst for the semiconductor industry, coming as it does on the heels of the generous capital-return policies that have already benefited shareholders. Perspective on Europe Great Rotation Has Mileage in Europe Europe had a very strong start to 2015 that was boosted by both the emerging economic recovery and the onset of quantitative easing (QE) by the ECB, which had created a substantially weaker euro and thereby increased optimism for corporate earnings, given that nearly 60 per cent of profits come from overseas. Moreover, for the first time in six years, we expect European corporate earnings to far exceed US earnings. As the second quarter progressed, we saw the first quarter s electric returns mitigated, as the euro regained some poise and fears emerged over a possible Grexit. Although we do not want to appear too complacent, we believe that fears over a Grexit are overplayed, since we expect any real market contagion will be addressed by the ECB s QE and other programs, but also because this is, in essence, a political problem, and we have learned that when it becomes darkest, the European Union finds a solution. Fears have also emerged over the ECB s determination to maintain QE, but recent statements show that these fears are misplaced. Thus with the ECB in action until the autumn of next year, clients should anticipate a weaker euro, as this is the clearest result of QE, which will continue to underpin equity valuations and earnings. Looking into the summer, we have a concern that many investors are short the euro and long European equities, and thus there may be some contrary moves. However, in the medium term, European stocks offer several benefits: good value compared with other global markets; a very attractive dividend yield; the excitement of industrial mergers and acquisitions as the journey to the United States of Europe continues, aided by Brussels deregulation; and Neil Dwane CIO Equity Europe a very attractive investment opportunity across asset classes within Europe, with negative- yielding euro cash and nearly negative-yielding bonds across many durations. As a result, the great rotation out of bonds and into equities should still have some mileage in Europe! 4

5 Heard at AllianzGI An Underappreciated Link Between Oil Price and EUR/USD Allianz Global Investors Insights There has been much market speculation recently about when the US Federal Reserve (Fed) will begin raising interest rates, and the effect that will have on the strength of the USD. Conventional market wisdom suggests that since last summer, the strength of the USD versus the euro (EUR) was driven by the relative central-bank policy trajectories, with the ECB starting its QE operations just as the market began to anticipate the first rate hikes in the US. This is despite a fair amount of academic research that suggests that relative interest-rate levels and central-bank policy have only a limited effect on exchange rates. If we look at the data, however, we find an unexpectedly strong correlation between the oil price and the EUR/USD exchange rate, as shown in the accompanying chart. While this in some ways defies the expectation that the euro has more to gain from low energy prices than the USD, it appears that one explanation could be that the major energy exporters have been recycling their export surpluses into euro reserve and investment assets. With the lower energy prices, suddenly they have been forced to start selling both sovereign wealth fund assets and reserves in order to cover their fiscal and current account shortfalls. The swing is worth about USD 200 billion per year and could be one reason why oil prices move in tandem with the euro. Indeed, the correlation of these two price levels over the last five years has been about 76 per cent, which is substantially higher than the 50 per cent correlation between policy rate differentials and the EUR-USD exchange rate. Nevertheless, the longer-term effects of lower oil prices probably benefit the European economy more than the US economy, and the positive effect on Europe s trade balance should also provide support for the euro-zone s common currency. Once energy prices stabilize and the oil exporters have adjusted Karl Happe CIO Insurance Related Strategies their fiscal policies to the new reality, the current euro price level could look like an attractive entry point. Certainly, as economic growth expectations converge and expectations for Fed activity moderate, the recent dollar strength may have reached its limit, as long as the oil price doesn t fall further. Oil Price vs. EUR/USD WTI EUR/USD Oil Price in USD EUR/USD Source: Bloomberg as at 8 June WTI is West Texas Intermediate crude oil. 5

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