PMC Weekly Review - February 20, 2015

A Macro View – Greece Dominates Headlines, U.S. Stocks Steady

If you’re not yet familiar with the word “Grexit” (Greek-exit), you probably should be, as investors and media figures are already overusing the term while speculating over the possibility of a Greek exit from the Euro and the potential global consequences. While the term was coined by two Citigroup analysts three years ago in the midst of the European debt crisis, it is now the catch phrase of the month. On February 8th, former Federal Reserve head Alan Greenspan told the BBC “it is just a matter of time” for Greece to withdraw from the European Monetary Union (EMU), and there are countless similar arguments hitting the headlines on both sides of the argument. Yesterday, Germany rejected Greek’s latest proposal for a six-month extension to its Eurozone agreement, on the grounds that it is neither a long-term solution nor commits Greece to the pre-existing conditions of its international bailout package. While many officials are predicting a deal being completed by the weekend, it is helpful to understand what the broad market is expecting in the event that Germany blocks Greece from another financial lifeline (their current bailout agreement will expire in less than two weeks) and the Grexit indeed occurs.

The lack of significant market volatility lately, despite the lack of progression towards a new deal between the International Monetary Fund (IMF), European Union, European Central Bank (ECB) and Greece, indicates that global markets are mostly “ok” with the idea of a Grexit playing out. The structure of Greece’s debt has changed considerably since 2010-2012; back then, the majority of Greek debt was owned by private investors, whereas currently, the IMF and ECB hold the majority of their debt and would be better suited to work with the Greek government in the event of a default. Global fixed income markets are pricing-in negligible contagion effect, as shown by Portuguese and Spanish 10-year yields of just 2.2% and 1.5% respectively (note these sovereigns are perceived as being equally/less risky than 10-year U.S. Treasuries, which yield about 2.1%). This is in contrast to Greek yields of 9.6% - a completely different ballpark - so while some bearish commentators on TV predict a Greek domino effect of other weaker EMU members defaulting/leaving the union, the bond markets are thinking otherwise. Lastly, the ECB’s new stimulus program was very well-received by investors, providing a positive backdrop for the entire region and offsetting concerns over unforeseen risks regarding Greece.

U.S. Markets continue to march forward, with U.S. large cap stocks up about 2.5% year-to-date and small caps up about 2.0%. Mid caps, the often-forgotten stepchild of the broader domestic equity asset class, are continuing their strong run from last year and are up about nearly 4% year-to-date. Earnings season has been very strong with nearly three quarters of companies in the S&P 500 beating their consensus earnings expectations. Earnings growth has been strong, which is important in this stage of the economic cycle where growth of earnings, rather than multiple expansion, tends to drive stock price appreciation. Regarding energy, data from the Energy Information Administration this week showed inventories of crude oil rising twice as much as expected last week – 7.7m barrels versus expectations of 3.1m barrels. So much for the formation of a bottom in oil prices… although consumers will continue to be delighted at the gas pumps. Oil had mimicked a recovery recently, increasing from $43 to $53 a barrel despite any solid fundamental or technical reasons, so when the latest inventory numbers broke yesterday and crude fell to $51, it was not at all surprising. While falling commodity prices have fueled deflationary concerns, prices of services (rent/shelter, medical, education), which make up 60% of CPI, are growing steady at 2.5%, and the broad fixed income market continues to think the Fed will begin raising interest rates in the second half of 2015.

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