Wednesday 25 April 2018

Paul Sommerville: Greece only asks that we take our foot off its head

'The response from the Chinese government has been to fuel, encourage and support this bubble - just as every other Central Bank has been doing to speculative assets all across the globe'
'The response from the Chinese government has been to fuel, encourage and support this bubble - just as every other Central Bank has been doing to speculative assets all across the globe'

Paul Sommerville

In Ireland, any discussion on Greece quickly descends into farce as politicians mask their domestic political agendas in rhetoric regarding Greece.

Our Government's shameful approach on taking a hard line on Greece is a direct consequence of its fear of looking silly and giving Sinn Fein a stick to beat them with in the next election. It is not based on any sound economic analysis.

The sad stereotypes endure of a reckless Greek people flittering away money as others pick up the tab. Last week's Marian Finucane Show on the eve of the referendum could not muster up even one out of seven panellists who thought the Greeks should vote 'No'. Joe Duffy commissioned a poll indicating 64pc of listeners thought that Ireland should not participate in a further bailout for Greece.

The Irish electorate have been sold a fable on the reasons Ireland is recovering and it is this misdiagnosis that leads to warped views on Greece. The huge fall in value of the euro (down 25pc vs the dollar, down 15pc vs sterling) have boosted exports and greatly helped tourism. Our multinational sector, selling in US dollars reporting in euro, has given our numbers a big boast.

The global asset price bubble mania has reached the commercial property market here - but we mistake it for confidence in our recovery. It is not. It is merely a rational trade when there are zero interest rates across the globe.

USA stock prices at record highs has encouraged those based here to increase employment. QE is helping Ireland a lot but somehow we believe that austerity works when in fact Ireland is recovering well, despite government policy, not because of it.

The Greek crisis is a tragedy and an obvious example of why austerity alone cannot work. The numbers over the last five years speak for themselves. It was clear that anybody who looked at the numbers in 2010 or 2012 with an objective eye could see those bailouts were never destined to succeed.

They were a mask for the financial sector to rape and pillage Greece for a further five years. It was an utter failure by the IMF and EU institutions and another bailout for banks all across Europe with the debts being passed on to the European taxpayer.

Of the €289bn given to Greece, 89pc of it went directly back to financial institutions. Greece has also been hopelessly mismanaged and pillaged by its own government and elites for over 20 years. But why is there so much hatred in EU circles towards the correct government in power for less than six months ?

It is simple. The elites fear the growing popularity of similar parties across Europe. Syriza polices are deemed radical left wing fantasy or, as Michael Noonan sneeringly put it "wealthy Marxists".

But the policies put forward are neither radical nor left-wing. They are sensible and are gaining support and if the Troika can have faith, they will be implemented.

The solution is simple. Greece's debt burden is unsustainable. A comprehensive reform programme implemented in parallel with a massive long term reprofiling of the debt that gives the country and its citizens hope is the only way forward. The idea that a Greek exit is somehow manageable or can be contained is utter fantasy. A hard default by Greece would cause chaos throughout Europe, from which it is unlikely to recover.

Contrary to the pessimists on Greece, I believe the country will find a path forward and recover well. If the EU and Irish government are foolish enough to force a Greek exit and hard default, I would wager that it would be Greece that would come out of the situation better in the long run.

Greece is not asking for a handout. It is merely asking for the foot to be taken off its head while the country is are drowning. Irish people should, above all, understand that.

Beware firms using cheap cash in share buybacks

The second quarter earnings season kicks off in earnest across the USA this week, with companies such as Google and JP Morgan reporting, among many others.

With all the euphoria and bullishness regarding stocks at the moment it is curious to note that all the main USA indices are flat or slightly down for the year thus far. Last Thursday, the IMF lowered growth forecasts for the US economy once again.

While the S&P 500 managed to post positive earnings growth in Q1, Q2 is looking less rosy. The estimated earnings decline for Q2 is -4.7pc. If this transpires to be correct it will mark the first year-over-year decrease in earnings since Q3 2012 and the largest decline in earnings since Q3 2009.

Even more troubling is the fact that top line growth is set to decline 4.4pc. For all those buying USA equities, you are now paying quite a premium for a dollar of future earnings at potentially the start of a Federal reserve rate hike cycle.

As estimates were lowered drastically for this quarter it is conceivable the estimates will be surpassed and the market may trend higher - but a look at the current trend of falling corporate profits would appear to be a potential negative influence on stock markets that are trading very near all-time highs, if not immediately then eventually.

The main pillar of the USA equity rally has been the companies themselves using share buybacks with cheap money to hide deteriorating corporate balance sheets. The pace of buybacks is now totally off the charts with some estimates showing they will exceed $1trillion for 2015.

This earnings season it would be wise to take note of those companies using share buybacks and financial gimmickry to hide disappointing earnings and avoid them. When the music stops these are the most likely to get hit the hardest. At the start of 2015 we issued a note to our clients suggesting the S+P index as a short trade on rallies for 2015. We are in a very small minority but we would stick with that guidance.

State-decreed stability won't calm the dragon

The selling pressure that has hit Chinese markets since June hit panic levels last week. And the Chinese government has only made the situation worse. Infinitely worse.

The Shanghai composite is down 34pc in just the past month. The Chinese authorities poured fuel on the fire by allowing companies to halt trading in their share price. Last Wednesday, with at least 40pc of all shares suspended, a further 31pc were limit down - meaning no more selling could be done. And so, a total of 71pc of all stocks in the world's second biggest economy suspended. A complete farce.

In order to allow a market to make a low, investors have to be able to sell in order to eventually exhaust the supply of shares to be sold. If an investor cannot sell, there cannot be a low. In fact, being unable to sell increases panic levels. The response from the Chinese government has been to fuel, encourage and support this bubble - just as every other Central Bank has been doing to speculative assets all across the globe.

It is too soon to say if this is the actual bursting on the Chinese equity bubble or a mere correction on the way to more insane levels - but it should be noted that when asset bubbles deflate they do so rapidly.

I see no reason why these sorts of corrections and price movements will not come to bond markets and other stock indices in the coming years. If you want exposure to this part of the world, you should be investing in high quality US or EU companies with exposure to China, or exchange traded funds that hold a much broader range of Asian equities - but certainly not Chinese stocks themselves.

Your friendly stockbroker will probably tell you it is a healthy correction in a huge bull market. We think the price action is anything but healthy.

Paul Sommerville is CEO and head of advisory at SAM.

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