Risk but we don’t care

More perplexing equity trading in the US overnight – Data was soft, oil fell, bonds were sold off, Greece is inches way from failure and China’s property slowed further.

Source: Bloomberg

Yet the Dow and the S&P 500 made new record closing highs and the futures markets in Asia are suggesting green screens will be seen on the open today. The collective belief behind this risk optimism remains the idea the Fed will hold off moving rates at the back end of 2015. US growth isn’t what you would call rapid or even solid. It is soft at best. The thought therefore is that the ‘data dependant’ Fed can wait.

Interestingly, Fed members are going to great lengths to explain that rates will move this year - with September still firming as the most likely month the Fed funds rate will rise (if only by a notch or less).

The risk to the equity market therefore is making me nervous – I have read several reasons why the ASX, Europe, the US etc. will continue to rise. The reasoning includes: record low rates, QE, the wall of money in safe assets collapsing, China’s deregulation – the list goes on.  I agree that over the medium term this will continue to support the price of equities and risk assets but these have been supporting equity markets for three years or more – exhaustion is coming and in the past month, the fundamental tortoise was finally catching the pricing hare – and was issuing a massive speeding ticket.

EPS growth is low – yet the more you listen to analysts, central bankers and even firms themselves, EPS growth of 3% to 5% is considered strong. In a world where GDP growth of 1.5% to 2% is considered ‘strong’, I can understand why EPS growth this low is considered strong. By historical standards it’s low – yet equities globally are making new record highs.

Fundamentals will always catch up with pricing and when it does the price of assets are in for a rude shock.

The other risk issue facing markets is sovereign risks – the most immediate sovereign risk being Greece. For us in the Asian region, Greece is currently seen as a side issue. However, contagion to euro trading and the general effect of the whole of EU should be a concern for Asia.

The Greek debt issue is intensifying; there are signs of disagreements between IMF and the European Commission around Greece’s debt and possible refinancing. Athens is steadfast in its demands that wages and pensions will be paid by the end of May – all other payments are to be negotiated (with creditors).

A report by the Bundesbank on Monday suggests that Athens is only being kept afloat by its emergency liquidity assistance (ELA) program which it is currently using to repay its debt coupons - not its intended purpose.

The outstanding amount from the ELA program is estimated to stand at €80 billion. It is also estimated that roughly €40 billion in bank deposits have fled the country (approximately 20% of total bank deposit in Greece). Greece has a €309 million repayment due on June 5 the total repayments in June are €1.5 billion - yet the bank collateral needed to back the ELA is believed have fallen to €95 billion at a stretch something that IMF will be unimpressed with – the current situation is unsustainable.

Creditors want some form of reform package – Greek debt to GDP stands at 177%; some form of debt reduction scheme is needed – which, according to reports coming out of Europe is still a way off.

If the Bundesbank report is correct Greece has about two to three weeks to find emergency funds or it will default. The shockwaves of this will come to Asia as the EUR gyrates and the fall out becomes clear - creditors will be left holding worthless Greek debt and massive haircuts – a tantrum is coming; will it come from Athens or from the creditors?

Ahead of Australian open

The ASX resumed its downwards trajectory yesterday. Most were pointing to the divestment of South32 as the main reason for the mass loss. This was not the case at all – on a readjusted price, BHP only fell by 0.5%. The pain on the ASX was down to the banking space.

This is why I am cautious about bold calls of 6200 plus points by year end. The yield trade in the banking space is facing a two pronged issue – The first is dividend growth at the banks has finally being checked (WBC and NAB have said enough is enough). The second, more pressing issue, is bond yields are pulling institutional investors out of the banks.

Ten-year treasuries are above 3% - the risk yield premium in equities is not enough to keep funds in the banks creating mass erosion on a total return basis. The fundamentals in Australian banks are looking stretched and expect the price to fall over the coming three months as the gap is closed. 

That, however, may not translate into trade today. The futures market was positive and we are currently calling the ASX 200 up 18 points to 5677. Iron ore and oil both fell overnight suggesting the miners and oil plays will be the drag on the market today - not the banks.


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