Investors waiting until Europe settles

Positive signs, however small, are emerging from Europe and the US, while China goes through growing pains.

FALLING volatility in share prices, in conjunction with falling trading volumes on Australia’s stock market, reflects a sombre reality that interest in the local market is fading. 

With the market failing to indicate a trend over the past four months, investors are waiting for a break in the Australian market, one way or the other.

Many investors have decided their funds will remain on the sidelines until a European resolution is realised.

The US, on the other hand, is now in a presidential election mode, and investors are focusing on the positive, having pushed that market to its best start since 1997.

Several factors are encouraging global investors. 

• According to the latest market data, the US economy appears to be holding-up, despite some misgivings about the downward trending jobless claims data and the weekly Economic Cycle Research Institute (ECRI) leading economic index having levelled over the past five months.

• China’s Gross Domestic Product grew 8.9 per cent in the fourth quarter from a year earlier, meaning it expanded faster than anticipated.

This has eased concern that demand from the world’s second-largest economy for industrial metals, such as copper, will falter.

Copper prices grew more than 8 per cent in January, after having fallen by 21 per cent during 2011.

“This is good news as it shows the economy hasn’t slowed as much as feared by some,” said Hong Kong-based Yiping Huang, chief economist for Emerging Asia at Barclays Capital.

• The massive injection of $US634 billion in low-cost three-year funding for the eurozone banks last month by Mario Draghi, president of the European Central Bank, has helped continental banks buy time to de-leverage.  

It is rumoured that an even larger cash infusion from the ECB is being planned for February.

By expanding its balance sheet more than the US Federal Reserve, to €2.68 trillion, the ECB has established credibility with those investors who hanker after bailouts.

This has had the effect of dramatically reducing the prospect of a Lehman Brothers-style banking collapse.    

The ECB scheme is not a permanent fix, but it has given eurozone politicians time to negotiate German Chancellor Angela Merkel’s fiscal compact.

• The latest European bond auctions exceeded expectations, with oversubscriptions in both Spain and Italy.  

One Spanish bond auction that sought €2.51 billon resulted in demand for €13.5bn.

• Greece, despite having endured a tortuous consultation process, may be on the verge of reaching an agreement with its creditors.    

Athens is negotiating with the Institute of International Finance, which represents Greece’s private creditors. 

Private bondholders are being asked to write-off half their Greek debt, and in return to accept cash payments and new bonds with longer maturities. 

The main sticking point in these discussions has been the interest rate Greece is paying on newly issued bonds that replace its existing debts.

The IIF has said it wants no less than 4 per cent, while Athens, backed by eurozone finance ministers, wants the rate to be set below 3.5 per cent.

Agreeing to a deal is a precondition of receiving further bailout funds from the European Commission, the ECB and the International Monetary Fund.

• Looking at Italy, it should come as no surprise that Italian Prime Minister Mario Monti, given his banking background, is working well in negotiations with the ECB and Germany.

Despite fears of public sector strikes, Mr Monti has moved ahead with the necessary fiscal cuts and competitiveness initiatives.

• The US Federal Reserve has indicated to the market to expect continued easy monetary policy for roughly the next three years. 

The ‘fed’ is in no hurry to raise rates and appears to be comfortable with the current inflation situation.

In the US, despite the prospect of between 8 million and 10 million further home foreclosures over the next six years, there have been signs of a recovery in housing sales and housing start-ups.  

In the tech sector both IBM and Microsoft delivered better-than-expected corporate earnings, leading to a 20 per cent rebound in the Nasdaq share index.

• However, there are other troubling issues that could spike the recent market upturn.

The fact that the ECB and Angela Merkel do not want private sector entities to bear any financial losses indicates that the European insolvency crisis will not be easily mended.  

Several major European banks would have collapsed without the ECB-financed long-term refinancing operation.

Preventing the private sector from taking losses is simply enshrining a dangerous moral hazard; however, it helps explain the recent short-term rally in Italian government debt.    

Germany has been pushing for Greece to relinquish control over its tax and spending decisions to a eurozone ‘budget commissioner’, as part of discussions over a second €130bn financial bail-out.

This new commissioner would have the power to veto budget decisions taken by Greece’s government if the decisions are not in line with targets set by international lenders.

This extraordinary control of a member state by the EU would mean that Greece faces the prospect of becoming the first 21st century German colony.

Just watch the political fireworks that will follow.

• Italy’s bond market is not yet out of trouble, with a total of €350bn in debt maturing steadily over the next year.

Portugal appears to be following in Greece’s footsteps, with bond yields and credit default swap spreads continuing to surge, resulting in a further bail out being required.

But with most Portuguese bonds having ‘negative pledge’ (bond-holder protection) clauses, cover-all loans from the so-called troika of representatives from the European Commission, IMF and the ECB, may not work. 

• Chinese authorities have spiked the country’s property market, and efforts to cool that growth, by restricting credit, is now translating into weaker sales for some US companies trading there.

US investment strategist, Keith Fitz-Gerald, said: “China is merely going through the first uncomfortable growing pains of its adolescence.”

While he doesn’t believe it’s the end of the world if China goes through a market correction, a rocky road may still lay ahead.

• The Baltic Dry Index, which tracks the cost of shipping major raw materials around the globe, has fallen by more than 50 per cent since November, and is 42 per cent below its normal seasonal level. This may signal a slowdown in global growth.

• Middle Eastern political risks may be this year’s ‘factor X’, with the potential for oil prices to escalate as a result.  

In weighing up all the key factors, the economic outlook for 2012 is shaping up to be as unpredictable as the one now past, with no-one having any clear idea in which direction markets will head.

• Steve Blizard is a senior securities advisor at Roxburgh Securities