Weekly Market Update – 29th May 2015

• Shares had a mixed week with US shares down 0.9% and European shares down 2.5% on worries about Greece, US economic data and the Fed and Chinese shares down 1%, but Japanese shares up 1.5% and Australian shares up 2%. The US$ rose on the back of stronger US economic data and this weighed on commodity prices and the A$. Bond yields also fell they’ve been moving inversely to the US$ lately – adding to confidence that the April-May bond sell off has run its course.

• Chinese shares had a sharp one day fall of 6.5% on Thursday, supposedly in response to tougher margin requirements and a People’s Bank of China (PBOC) effort to drain liquidity, prompting some to wonder whether its bull market is over. However, this is unlikely. First, a 6.5% one day fall is not unusual for China (there was 7.7% decline January 15) and it needs to be seen in the context of a 43% gain year to date and a 126% rise over the last year. Second, the huge gain in Chinese shares over the last year has only unwound dirt cheap valuations with the forward price to earnings ratio rising from around 8 times to around 17 times, this is around Australian and US levels but below its long term average. Finally, the PBOC moves in the last week look like normal liquidity management with further monetary easing likely. So all up, we see this as just another correction in an ongoing Chinese bull market.

• Getting close to crunch time for Greece. While a payment is due to the International Monetary Fund (IMF) on June 5, Greece apparently has enough money to make the payment and in any case this and other June IMF payments can be delayed till the end of June, so there is a bit more time to reach an agreement than commonly feared. Our base case remains that a funding deal will be reached in time allowing Greece to head of a payment default, or “Graccident”. However, while there has been some progress the two sides are still apart on some issues and even if a deal is reached a missed payment may still occur if the deal needs to be passed by the Greek parliament or put to a referendum. A Graccident won’t necessarily lead to a “Grexit” (or Greek exit) from the Euro though and it could just force the Greek Government to see common sense or be replaced by a more sensible government. This all has the potential to cause more volatility. But whichever way it goes the threat of contagion to other peripheral countries is low compared to the 2010-12 period.

• A poor showing by Spain’s Governing Popular Party (PP) in local government elections has raised fears that Spain will go the way of Greece at a general election due later this year. However, this is unlikely as: apart from a win in Barcelona the anti-austerity party Podemos didn’t do that well and has been seeing declining support; the rise of the more pro-business and liberal Citizen’s party is drawing support away from Podemos; the Governing Popular Party still receives the most support; and Spain’s improving economy may see support for the Government improve over the next six months.

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