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Broadgate: Weekly Briefing 29/6

29 June 2012

Spain – Spanish Prime Minister Mariano Rajoy has said Spain cannot afford to finance itself for much longer at current rates. Spanish 10-year government bonds have been trading at yields above 6.8%, coming close to the 7% that is considered unaffordable.

Mr Rajoy was speaking ahead of this week’s European Union (E.U.) summit. “The most urgent subject is the subject of financing,” he said. Spain has asked for funding for its banks, but the country has not been bailed out.

Eurozone countries have agreed to lend up to EUR100bn to support Spain’s banks.

China – The E.U. has asked the World Trade Organization (WTO) to arbitrate in a row about China’s export restrictions on its “rare earth” minerals.

The E.U., along with the U.S. and Japan, has asked the WTO to set up a dispute settlement panel, arguing that China is being unfairly restrictive.

The term rare earth refers to a group of 17 elements that are used to make a range of hi-tech gadgets. These elements are used in products ranging from MP3 players to mobile phones, flatscreen TVs and hybrid batteries.

With those products becoming increasingly popular, the demand for rare earths has been rising.

China – China is to provide a GBP6.4bn credit line for Latin American countries to support infrastructure projects in the region. The proposal was made by China’s Premier Wen Jiabao as he wrapped up his visit to the region.

He also proposed a free trade pact between China and South American trade bloc ‘Mercosur’, which includes Brazil, Argentina, Uruguay and Paraguay.

Many of the Latin American countries are still at a development stage and are building new infrastructure in a bid to boost growth in their economies.

Meanwhile, China, which has the world’s largest foreign exchange reserves, has been looking to for new areas invest some of its cash.

India – Indian Prime Minister Manmohan Singh pledged to restore confidence in Asia’s third-largest economy as he resumed control of the finance ministry after growth slowed to the weakest in almost a decade and the rupee slumped.

Singh, 79, urged senior ministry officials to act quickly to revive investor sentiment as he assumed the role vacated this week by Pranab Mukherjee, who resigned to run for president. India needs to address “problems on the tax front,” as well as in the mutual funds and insurance industries, he said at a meeting in New Delhi.

“Don’t expect a big change yet,” said Ramya Suryanarayanan, a Singapore-based economist at DBS Group. “If until now there were bottlenecks and policy logjams it’s not going to miraculously disappear.”

Cyprus – Cyprus has told the European authorities that it intends to apply for financial assistance, the fifth eurozone member to do so.

It said it needs help to shore up its banks, which are heavily exposed to the Greek economy.

The country needs to find about approximately EUR1.8bn over the next few days to recapitalise its second largest lender, Cyprus Popular Bank.

In a short statement, the government said that it required assistance following “negative spill over effects through its financial sector, due to its large exposure in the Greek economy”.

U.S. – Orders for durable goods climbed more than forecast in May, easing concern that U.S. manufacturing is faltering.

Bookings rose 1.1%, the first increase in three months, a Commerce Department report showed. Excluding the volatile transportation equipment, orders for goods meant to last at least three years advanced 0.4%.

“This comes as a relief that businesses aren’t completely cutting back,” said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto, who projected a 1 percent gain in orders. “We still have to be quite cautious as there is considerable uncertainty. U.S. growth will be moderate.”

Russia – Russia’s BBB debt rating was affirmed at Standard & Poor’s this week, which cited low government debt levels balancing risks for the world’s biggest energy exporter from commodity-price swings.

“The stable outlook reflects our assessment of balanced risks to the ratings,” S&P said in a statement. “Vulnerability of the budget and the economy to fluctuations in key export prices are offset by low government debt levels and the country’s slight net external asset position.”

“The confirmation of the rating is a positive for Russia given the very adverse global backdrop and very significant fall in oil prices” said Ivan Tchakarov, Moscow-based chief economist at Renaissance Capital.

Spotlight on: looking past the past

In the run-up to 2012’s halfway point, industry commentators have expressed concern that memories of last summer’s crash are blinding long-term investors to the current low equity valuations.

There is a remarkable symmetry between the course of markets in the half-year to-date and their trajectory in the same period in 2011.

However, there is a massive difference in sentiment. In contrast to the optimism of last year, investors are far more sanguine about the prospects for the rest of 2012, and it seems that much of this is down to what happened last August.

In just a little over two weeks the FTSE fell 15%, as the European authorities finally admitted Greece would need a bailout, and IFAs say investors are still suffering the psychological scars.

Graham Toone, head of research at AFH Wealth Management, claims it is getting harder to persuade clients to look past temporary market reversals.

“We try to get our clients to look through these wobbles. There are people out there who get very nervous about short-term volatility,” he said.

“We all feel the pain when the markets have a wobble, but you have to stand back and try not to get too caught up in the fear.”

The eurozone crisis hasn’t gone away, of course, and governments seem to move from summit to summit and from stop-gap to stop-gap, without any medium-term plan to calm markets.

“If the eurozone wasn’t around there would be another issue I’m sure, but right now Europe is determining investor sentiment,” said AWD Chase de Vere’s Patrick Connolly.

“What we have seen is lots of volatility and we are in for more of the same.”

“Markets are driven by macro events at the moment. The eurozone is pushing prices up or down with each announcement or downgrade.”

One of the most obvious differences between sentiment last year and this is the general reluctance to make predictions.

News headlines claiming the eurozone will inevitably break up or stay together are not as common as they were.

Claims that China will pull the world out of recession or sink with it are also less forcefully expressed.

For example, Neither Toone nor Connolly wanted to make any predictions for the year ahead; however, Connolly believes cheap valuations mean there is only one winner in the equity versus bond debate for the long-term investor.

“I am sure there will be up and down periods, however I would not assume what happened last year will happen again. I wouldn’t be surprised either way to be honest,” he said.

“The safest assets have become more expensive and will likely get even more expensive, while the riskier assets meanwhile will get cheaper and cheaper.”

Toone added: “The market seems to be relatively steady right now, but you find it hard to be too excited or frightened by things.”

“We still favour the more defensive areas of the market in this tough macro environment.”

“On a strategic level we are sanguine on our equity rating and we like high yield bonds. We are still very wary of gilts, we prefer high yield bonds.”

Another reason for the general lack of enthusiasm for the year ahead may be the growing realisation that the difficulty will last for years to come.

“We’re all waiting to see the E.U. come up with a plan to resolve the crisis, but I’m afraid the solution might not be too pretty either,” said Connolly.

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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