Let’s say that Monday’s deal on rescuing Greece—again—holds together. The Bundestag votes Yes on the deal. Enough of that small collection of private holders of Greek debt decide to take the buyback offer to make the International Monetary Fund happy. Greece actually gets 42.5 billion euros in December, enough to recapitalize Greek banks and to enable the Greek government to pay suppliers that haven’t seen a drachma…I mean a euro…in eight months.
Then what? What does the Greek deal mean for financial markets?
And nearer to home, what does the Greek deal mean for your own portfolio?
Usually the answers to those questions begin and end with what’s going to happen in Europe. Will Spain go bust or break up? Will Ireland continue its recovery? Will France join the PIIGS even as Greece drops out (to turn PIIGS into PIIFS)?
But let’s call a jamon a ham and admit that Europe isn’t exactly the center of the financial action even if it isn’t in crisis. It’s not, after all, as if anyone is expecting any economic growth out of the EuroZone any time soon. Greece and Spain and Italy and France…are in recession and likely to stay that way for a while.
But that doesn’t mean the Greek deal isn’t extremely important to your portfolio. In fact the Greek deal and the (temporary) move of the euro debt crisis from boil to the back burner will be the defining event (or non-event, if you will) for global financial markets for the next few months. The Greek deal doesn’t mean you want to invest in Europe but it does point the way for where you do want to invest.
I can think of 10 ways that the Greek deal will shape success and failure in global financial markets over the next few months.
- The move of the euro debt crisis from boil to simmer will reduce the demand for safe haven currencies such as the yen and the dollar. Oh, I don’t expect the euro to soar—everyone knows that the Greek deal didn’t really fix any of the EuroZone’s long-term problems. But a move up from the $1.2891 close on November 28 to something like the $1.3084 of September 18 or the $1.3214 of April 30 is certainly possible. BNP Paribas projects $1.33 for the euro by the end of 2012. That move isn’t so big in itself but any move up in the euro raises the possibility that traders selling euros to buy yen or dollars could see a loss. The trade isn’t a guaranteed win. And that would be enough to restrain the flow into the yen and the dollar.
- A modestly declining dollar is good news for the price of gold, copper, oil, and other commodities priced in dollars. As the relative value of the dollar declines, the dollar-denominated price of these commodities climbs. Exactly how much the dollar might fall in the next few months will hinge on the degree of worry about the U.S. economy heading over a fiscal cliff.
- A modestly declining yen would be good news for Japanese exporters who get killed when a rising yen makes Japanese goods more expensive to non-Japanese customers. The degree of weakness in the yen depends on exactly how dysfunctional Japanese politics become as the opposition Liberal Democrats fight to bring down the troubled Democratic Party government.
- By taking Europe’s economic woes out of the spotlight at center stage, the Greek debt deal will shift more attention to other global growth (or non-growth stories.) That increases the power of news about the U.S. fiscal cliff and on China’s growth rate to move global financial markets. For an example look to the whiplash in global markets on November 28 as prices first dropped on pessimistic remarks from Senate Majority Leader Harry Reid (Dem.-Nevada) and then rallied on optimistic remarks from President Barack Obama and House Speaker John Boehner (Rep.-Ohio.) Remember how—before euro crisis fatigue set in—every remark from Angela Merkel or Mario Draghi moved the markets? Well, look for a replay with a cast of characters from the United States and China taking over the stage.
- Setting the euro crisis on simmer actually raises the stakes for negotiations over the U.S. fiscal cliff. While the euro was in full crisis, U.S. fiscal and monetary policy didn’t have to be especially intelligent or effective for the U.S. dollar to strengthen and for the price of U.S. Treasuries to climb—sending U.S. interest rates lower. All the United States had to be was less scary than the EuroZone. But now that the fear factor in Europe has been set somewhat lower, the United States isn’t such a knee-jerk refuge. If U.S. politicians do something stupid that raises the fear of another downgrade to the U.S. credit rating, beware arguments that a downgrade wouldn’t be important since last time—when the United States got downgraded from AAA to AA—Treasury prices went up and U.S. interest rates went down. But U.S. assets then had the safe-haven winds from the euro debt crisis at their back. If the EuroZone hits some kind of stability for a while, U.S. financial assets wouldn’t have the same degree of support from safe-haven buying after a downgrade.
- A scenario that combines fear of a U.S. fiscal cliff with a gently declining (or worse) dollar plays out very differently for assets such as gold and commodities than the EuroZone crisis did. Then a wave of fear from the crisis led to a falling euro, a rising dollar, and falling gold prices (because the dollar was climbing) on many days. That was sure frustrating for any investor or trader that had bought gold as a fear hedge. This time, though, a scenario would include a falling dollar, and gold and other fear hedges would actually pay off in my opinion.
- As we learned from the EuroZone crisis, it’s not just the presence or absence of fear that matters but the degree of that fear. Fears that Spain would follow Greece have never vanished, but global financial markets were able to move up on other news when it didn’t look like Spain was about to plunge into the abyss in the next few days. When that plunge looked imminent, though, that fear dominated financial markets and made it hard for any other story to break through. Same now with the U.S. fiscal cliff. When fear of a near-term disaster soars, it takes down all global markets. But when it recedes to the level of a stomachache—instead of appendicitis—markets can rally on good news from the U.S. housing market or from U.S. retailers or from Chinese industrial companies. I’m of the belief that Washington will work out some kind of EuroZone style solution—part kick the problem down the road and part detail-light action—for the fiscal cliff that will be enough to keep fear in check for the rest of 2012 and into 2013. If that’s the case, then the good news—that the U.S. housing industry is in recovery and that rising home prices are adding to consumer confidence, and that in China September marked a bottom for the country’s economic growth rate and that GDP growth is headed back toward 8% rather than to a drop below 7%–stands a solid chance of moving global stock prices (even for European export-oriented stocks despite the EuroZone recession) modestly higher in 2013. Remember that nothing feels quite so good when you’ve been banging your head on the wall (EuroZone debt crisis and U.S. fiscal cliff) for months as stopping. That’s a good description of the positive story for 2013.
- The evidence keeps building that China’s economic growth rate bottomed in September and is in rebound mode—although headed for a modest rebound. For example, profit at China’s industrial companies climbed 20.5% in October after a 7.8% gain in September. Before you go all goggle-eyed at the figures, some context: The improvement was just enough to push profit growth at these companies into positive territory for the first 10 months of 2012. For the year to date profits are now up a not-so-huge 0.5%. That is, however, better than the 1.8% year-to-date decline for the nine months through September.
- Don’t let the continued lackluster performance of the Shanghai Stock exchange, where the Shanghai Composite continues to bump along near the 2000 level, determine your investing stance toward Chinese equities. Truth is that the Shanghai market, dominated by domestic Chinese investors, remains extraordinarily pessimistic—stock prices are at January 2009 levels and the index is down 9.5% in 2012. I think that’s because Chinese investors and traders who have been looking for something dramatic out of Beijing on stimulating the economy have been disappointed by the government’s actions to date. The Hong Kong stock market, however, which is dominated by international money, is up 15% since the start of August. Investors in Hong Kong shares are seeing the pickup in growth—with or without splashy stimulus packages—as a reason to buy. I think Hong Kong is a leading indicator on China’s growth story and more accurately reflects the pickup in China’s economy. Shanghai often takes a while to shift gears from a focus on politics to an emphasis on the real economy.
- If the U.S. fiscal cliff delivers a fender bender rather than a crash that totals the car, if the EuroZone crisis remains on simmer for most of 2013 (until Greece runs out of money again, shortly after the German elections in the fall in the best case scenario), and if growth in China looks like it will hold at 8% or slightly better in 2013, then I think the biggest beneficiaries will be emerging market stocks. The China story will convince global investors—rightly in some cases and over-optimistically in others—that the rising tide will lift all boats and that the absence of a pressing global crisis makes it safe to take on more risk. Watch to see if the rally in Hong Kong is followed by a rally in Brazil and then Mexico and then…. The biggest gains will be in those markets that would take the biggest hit if the risk on trade goes back to risk off. So 2013 won’t be a year for buying Turkey or the Philippines or Colombia and then forgetting about them. Try not to get whiplashed by the daily shifts in emotion, but do watch—with an eye to taking profits—for a real return of fear based on an unexpected move back to boil in Greece and Spain or a fiscal cliff wreck in the United States.
2013 looks like it’s shaping up as another year when the real news flow—if you can separate it from the emotional reaction to the noise in the news—will drive financial markets. There is the possibility for a good year ahead or maybe just for a good first half—if the fear level remains set at “moderately distracting” rather than “head-for-the-hills.”
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of owned shares of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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