Monday, 7 November 2011

Markets force the issue – first with Papandreou and next with Berlusconi?

Mike Lenhoff's market tactics - 7 November 2011


Anyone looking for a quick fix on eurozone fundamentals can take it from Angela Merkel that it’s not going to happen. As she said over the weekend, a solution to the debt crisis could last a decade. To quote: the ‘very painful path’ is one ‘on which we have to go step by step.’

No doubt the sentiment is widely shared. However, given that equity markets are so wholly consumed by the eurozone’s sovereign debt crisis, does it also mean a decade of de-rating for equity markets where, as shown in the chart, investors continue paying less for earnings? Of course the eurozone may not survive a decade in its present constituency, or any other.

One such step is Greece’s government of national unity which, under the favoured leadership of Mr Papademos, is to serve a sole purpose, this being to ensure that before elections can be held, which are unlikely before the New Year, parliament votes through the austerity measures associated with the new €130bn programme agreed in Brussels last month.

For the interim prime minister the job is also to regain for Greece whatever credibility has been lost with its Eurozone partners. With an unemployment rate of over 16 percent hard times cannot be popular. Yet the interim government’s task may be partly aided by an electorate that appears broadly in favour of remaining in the eurozone. Amazing! Given his ECB credentials, Mr Papademos is one who knows what needs doing but a bit of luck, a fair wind and a show of goodwill should help.

Financial markets are also likely to focus on Italy where push might now come to shove for Prime Minister Berlusconi. Reports indicate that tomorrow’s vote in parliament over Italy’s public sector finances is likely to be compromised by rebels within his own party but the indication is also that even if the prime minister survives tomorrow’s vote, preparation is underway for a no-confidence motion intended to bring Mr Berlusconi down. Maybe Mr Berlusconi will simply step down.

Elsewhere, Chinese inflation features in this week’s economic news. A further deceleration in the rate is expected to some 5.4 percent and this should set the stage for a cut in banks’ reserve requirement ratios in an effort to ease the tight credit conditions faced by small and medium sized companies.

While help for SMEs has been provided through an assortment of tax concessions the central bank is reluctant to reduce interest rates. However, if the authorities let the renminbi continue appreciating more rapidly, as it has been doing very recently, this will bring disinflationary pressures of its own to an economy that is losing momentum. This puts policy easing by the PBoC is on the cards but it is likely to start with cuts in reserve requirement ratios, which we expect shortly.  

Equity markets start the week under pressure. Greece’s government of national unity is an important and welcome step but for Italy there is a crisis of confidence and it is likely to be this to which the markets are reacting.
Picking up on the de-rating idea, investors may not be paying up for earnings but, importantly, the earnings coming through provide for growing dividends. While the eurozone sovereign debt crisis is capping the progress equity markets can make, the dividend yield is rewarding patience – though hopefully not a decade of patience. It might run a little thin. Disclaimer >   

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