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ABSTRACT: The global markets had nowhere to go but up this week following a rout that carried over to at least Wednesday before reversing direction. Despite this modest recovery, investors remain uncertain about the health of the Chinese equities market and the potential for Greece to reach a new deal with its creditors by Sunday’s deadline.

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GOVERNMENT & POLICY

News & Notes

The Swiss franc is up 12% this year, far outperforming every major peer currency after the currency was decoupled from its 1.20-per-euro foreign exchange peg late last year.

The IMF warns the Federal Reserve that the global economy faces significant risks from the eurozone crisis, suggesting that the Fed delay its first rate hike until at least 2016.

The FTC finds that major banks in the U.S. have so many subsidiary operations, with confusing and overlapping legal structures, that the road map connecting these institutions would be difficult to unravel in the event of a bankruptcy. Last year, regulators found that the resolution plans of Bank of America, JPMorgan, Citigroup, Goldman Sachs, Morgan Stanley, and others were insufficient to handle a bankruptcy in an orderly manner.

The State Bank of India (SBI) delays the sale of $1.5 billion in bonds, citing the unfavorable conditions created by uncertainty and volatility surrounding Greece.

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MARKETS

Impact of Crises in Greece, China Still Being Felt

The markets trained their focus on Europe this week as the stand-off between Greece and its European lenders intensified. The news coming from the negotiations is finally pointing toward a deal just over the horizon; the downside is that the horizon is fast-approaching. Greece meets with eurozone leaders at a summit on Sunday.

The EURO STOXX 50 and CAC 40 both fell more than 2% on Monday as investors tried to prepare themselves for the fallout from a possible Grexit by snapping up German bunds, Swiss francs, and U.S. dollars. Despite a fleeting 2.4% gain for Shanghai, the Nikkei 225 lost 2% and the Hang Seng index tumbled 3%. Thanks to the ISM non-manufacturing index rising to 56.0 in June, Wall St opened about 0.25% higher and traded mostly flat thereafter. The euro settled at about $1.105, the yen strengthened to 122.5 per dollar, while 10-year Treasuries rose slightly.

Crude oil saw its worst trading day of the year amid the impasse of the Iran nuclear deal in addition to the mayhem in China and Europe. Brent crude lost 5.9% while WTI crude sank 7.4% lower on the day. The precious metals were mixed, with gold silver advancing about 0.35% each and the Platinum Group metals staggering to the closing bell around 2% lower.

While fluctuating sentiment over Greece certainly had an affect on trading throughout the week, Tuesday’s movement was driven more by the release of new economic data. Exports fell by the most in 3 months during May thanks to the strong dollar, growing the trade gap by 2.9%. Yet, home prices rose in May at their fastest annual pace in 10 months, and job openings hit an all-time high during the month.

The dollar rose 0.9% to 97.15 on the DXY, helping keep crude oil and the precious metals capped. This sent the euro to a 5-week low against the dollar at $1.09, while the pound sterling hit a 1-month low of $1.54. Demand for Treasuries surged, pushing 10-year T-note yields as low as 2.19% before moving back to 2.25%, while 30-year yields dipped below 3%. The euro returned to $1.10 while the crude benchmarks rallied. U.S. indices trended into positive territory by about 0.5% during afternoon trading, though the Nasdaq lagged behind. Abroad, only Australian (+1.94%) and Japanese (+1.31%) shares closed in the green.

Tuesday was the busiest day of action in precious metals trading of the calendar year, with spot prices plunging across the board: gold lost $15, platinum fell by $25, palladium sank more than $30, and silver fell by 70 cents, or about 4.5%. The gold price hit a 15-week low as the metals continue to bottom ahead of a potential rate hike from the Fed this autumn. The weakness in the precious metals has spurred solid retail sales of bullion items over the summer, however.

Wednesday was characterized by disconcerting electronic malfunctions with the computer systems of two major entities in the U.S., United Airlines and the New York Stock Exchange. While the glitch at United caused hundreds of flights to be delayed for about 2 hours, the blackout of the computer feed at the NYSE dragged on for four hours. Though trading of shares listed on the NYSE continued at other exchanges, the disruption stoked fears of cyber attacks, bringing into question the security of all manner of important data stored and transmitted electronically. It was richly coincidental that the two purportedly unrelated technical glitches occurred on the same day, at nearly the same hour of the morning.

To make matters worse, Wednesday saw the bottom finally fall out of the Chinese stock market. Shanghai lost 5.9% on the day—mind you, with 10% limits on how much a share can rise or fall on a single trading day—while Hong Kong’s Hang Seng index tracked closely behind at 5.8% lower. This helped the precious metals turn slightly positive by the end of trading, while the crude oil benchmarks rose on the extension of Iran nuclear talks to Friday, and again through the weekend.

U.S. indices fell by about 1% on Wednesday morning, while the dollar slid to 96.45 on the DXY. Meantime, the euro was off a 6-week low, while the yen (under 121 per dollar) and the pound ($1.535) each lost ground, as well. The sell-off in Shanghai dragged Asian shares into the red, while Europe treaded slightly above water. The 10-year T-note settled back at 2.24%. News came that Albertsons, the nation’s second-largest grocery chain, plans an upcoming IPO. Meanwhile, shares of Microsoft traded lower after the company announced it would be cutting 7,800 jobs and writing down its $7.6 billion business through Nokia in the near future.

The FOMC meeting minutes from June were also released on Wednesday. Although the Fed statement typically moves markets, especially with the persistent question about the timing of the next increase to the federal funds rate, this month’s meeting minutes were rather uneventful, revealing that the committee consensus remains largely unchanged: inflation is still too low, and the members expect September of this year to be the most likely target for the first rate hike. Many analysts and “Fed watchers,” however, have expressed difficulty believing a rate hike will occur anytime before the end of the calendar year.

Thursday saw U.S. indices again jump higher at the opening bell only to trade lower throughout the day and close near unchanged. The precious metals slid back again, while Treasuries fell, lifting 10-year yields near 2.40%. To put the level of unpredictability in the markets into context, the VIX (a gauge of market volatility) rose 20% last week, the most since January, and has itself been more volatile, dropping by more than 5% on Tuesday before surging 18% higher on Wednesday. The increased volatility is somewhat atypical for the doldrums of summer, which speaks to the unusually high level of geopolitical and economic strife gripping the international community.

As Greece made its first real progress in talks with its creditors, and China’s stock market rallied 4.5%, Friday saw renewed optimism from the markets that everything will sort itself out eventually. Shares of Apple did post a 5-day losing streak on concerns about its heavy investment in the Chinese market, though investors were otherwise bullish on stocks on Friday. European shares traded as much as 3% higher, with Athens’ main index better than 2% in the green, while U.S. equities advanced by more than 1%. Though spot gold was flat at $1,160/oz by week’s end, the other precious metals all gained modestly on a soft day for the dollar; the DXY tumbled by more than 1% to 95.5, helping boost the yen, pound sterling ($1.55), and euro ($1.1125) as a result.

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M&A News

  • Dollar Tree acquires Family Dollar for $8.5 billion.
  • The Aetna-Humana deal puts pressure on a possible Anthem-Cigna acquisition. While Anthem continues to haggle, the FTC is investigating the fairness of the Humana merger.
  • Israeli drug-maker Teva increases its bid for Mylan by $2 billion to $43 billion ($88/share). Mylan was rebuffed by rival Perrigo for its own $32.7 billion takeover bid.
  • Horizon Pharma’s $3 billion bid ($29.25/share) as part of a hostile takeover of Depomed is rejected, the third time Horizon has been turned away by the company.
  • Potash Corp may be interested in raising its bid to buy rival K+S after previously being spurned.

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GEOPOLITICS & WORLD EVENTS

Greece Defiant in Tone Only

So the Greeks voted “No” in last weekend’s plebiscite to (supposedly) decide the country’s fate in the eurozone, but now their government seems to be accepting “Yes” instead.

The Greek government is closer than it’s seemingly ever been to reaching an accord with its creditors that will offer some measure of debt relief matched with economic reforms undertaken by Greece. The tenets of a new agreement sound eerily reminiscent of the very measures that Greeks were apparently rejecting with their 61% support of “No” to creditors’ demands. Naturally, the Syriza-led government of Greece is now . . . hewing to creditors’ demands.

This is standard procedure for the Greek debt saga if you’ve been following along for the past 6 months. Perhaps the brinkmanship of Syriza is made more jarring against the backdrop of “extend-and-pretend” that has characterized the crisis from the start. Really, the melodrama stretches back five years now to Greece’s first bailout in 2010. This is what fatefully set this year’s events in motion, as the ill-conceived rescue attempt necessarily led to our current quagmire.

The IMF has rightly criticized its own wishful analysis of whether or not the 2010 bailout of Greece would work, though this concession obviously comes far too late for the debt-ridden Greeks. Meantime, the Europeans have been quiet about how the second bailout in 2012 essentially went toward reducing large French and German banks’ exposure to Greek debt rather than actually lifting any of Greece’s burden. Today, these lenders are whole and thriving while Greece is mired in one of the worst economic contractions since the Great Depression.

In order to try and placate its creditors, outspoken Greek Finance Minister Yanis Varoufakis stepped down from his post in favor of centrist, Oxford-educated economist Euclid Tsakalotos, who has been the lead negotiator during much of this year’s talks. European finance chiefs were frustrated that Tsakalotos, like his predecessors, showed up to negotiations empty-handed but full of promises. On Wednesday, the new minister did submit a request for a new 3-year loan to cover Greece’s mounting short-term expenses.

The negotiations have squarely shifted to Greece’s court thanks to the hardline stance that political pressure has forced German Chancellor Angela Merkel—widely seen as Europe’s most powerful leader—to take. Merkel has insisted that Greece must implement reforms before it can see any additional debt relief (e.g. a bridge loan), although the reality is that the ECB and the European Stability Mechanism (ESM) will undoubtedly step in to keep Greece afloat in the event of a new agreement. The bank holiday in Greece can only last so long before a humanitarian crisis sets in. That doesn’t even take into account the painful transition from the euro to a new drachma, or even a parallel currency of IOUs. It has been pointed out that this move, however, is a direct violation of EU statutes regarding the issuance of parallel currencies.

Sunday has been tabbed as the definitive final deadline for Greece to come to some resolution with its creditors. A summit held on the day will be attended by leaders from all 28 member countries of the EU, many of whom are experiencing fatigue over the constant attention on Greece over the last several months and years. While most of the terms of a new loan agreement seem to be agreed upon, all that remains is for the two sides to demonstrate the political will to keep Europe united—even if that means amending the rules of the monetary union.

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In China, the Wheels Fall Off

With the Chinese stock market in absolute freefall, the government has intervened in order to keep equities propped up at unjustifiably high levels. Following last week’s rout, a group of some of China’s largest brokerages pledged ¥120 billion ($19.3 billion) collectively over the weekend to create a large-cap stock fund to support tumbling share prices. Thousands of firms had trading of their shares halted, while regulators also barred high-ranking executives and corporate directors from selling their shares for the next six months. At least 28 firms cancelled IPOs, and it appeared that the crowds of investors who entered the market on margin (and accumulated loads of margin debt in order to ride the wave upward) simply could not unwind their positions fast enough.

Though these efforts are intended to stabilize the market after it experienced its worst 3-week stretch since 1992, they have in fact had the unintended consequence of eroding the confidence of retail investors in the government and its attempts to artificially keep markets afloat. Even as Shanghai lost 5% and 6% in individual trading sessions this week, two of the country’s largest firms, PetroChina Co. and Industrial & Commercial Bank of China, saw their shares climb thanks to state-sponsored buying.

These sorts of distortions (such as helping push PetroChina to the world’s second-largest corporation by market cap behind Apple Inc.) are in stark opposition to President Xi’s promise to encourage natural market forces to direct the market rather than the heavy hand of the state. The state-run media has been claiming that the stock downturn is the result of foreign investors with nefarious agendas, or that short-sellers are circulating dangerous rumors in order to game the markets. The problem with these theories is that foreign investors still make up less than 3% of the shares on mainland exchanges, while short positions account for just 0.03% of market capitalization.

Not only did Chinese equities lose value at a pace of about $1 billion per minute of trading over the last 3 weeks, but the government’s insistence upon widespread stock ownership has ballooned the number of retail investors on the mainland, who now outnumber members of the Communist Party.

Wednesday was perhaps the worst day of the downturn, as the souring sentiment spilled over into China’s regional neighbors: Shanghai’s 5.9% loss was followed by a 5.8% slide in Hong Kong, and greater than 3% losses from both Japan and Taiwan’s main indices. In another concerning sign, the gap between the value of shares in Shanghai and their discounted prices in Hong Kong (some 49% lower) for foreign investors is widening to its largest since 2009, showing the perceived riskiness of Chinese shares is currently very high.

Nevertheless, Goldman Sachs analysts are insisting that there is no equity bubble in China, and that this is an opportunity to “buy on the dips.” Goldman sees a 27% rally for China by year’s end. At minimum, the Chinese markets must unlever quite a bit before they are again an attractive emerging market investment beyond speculation. As the real economy in China continues to slow, it could literally take years to bring everything back into balance—and that’s only absent the excessive government meddling that shows no signs of abating.

All told, the Chinese equities market may suffer the same fate as Japan’s, which crumpled in 1987 after a period of exuberance and has never returned to even half of its high water mark a quarter-century later.

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Chinese Stock Crash Statistics

~Chinese equities lose $3.9 trillion in a matter of weeks, much of which triggered huge margin calls.

~The shares frozen from trading on mainland exchanges represent 40% ($2.6 trillion) of the total market capitalization of the Chinese stock market, or the equivalent to the annual GDP of the German economy, the world’s fourth-largest.

~The Shanghai Composite index is 32% off of its high in mid-June, while the Shenzhen index is down 40% over that span.

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News & Notes

Carnival Cruises receives approval from Treasury Department to begin taking cruises to Cuba next year now that the two nations are normalizing relations after 60 years of embargo.

The deadline for an Iran nuclear deal is pushed back three days from its Friday cut-off, as talks have remain stalled. Crude oil prices are weaker of late as significant Iranian oil inventories have yet to hit the market.

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A LOOK AHEAD: On Monday, the Treasury budget (budget deficit) will be released in the U.S. while India’s CPI will also be announced. Amid a flurry of important economic data from abroad next week, Fed Chair Janet Yellen will be speaking on both Wednesday and Thursday morning at 10 am EST.

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