Greece lightning strikes again! (Full Note Attached)
* Equities being buffeted by risks of a Greek “accident”…
Three weeks ago we upgraded our stance on markets from tactically cautious to
cautiously constructive as the rise in bund yields and the euro had gone far enough. The
main reason for the ongoing caution was Greece, as we found few investors really
focused on it at that time. That has changed markedly in the past few weeks, as the
risks of a Greek “accident” have increased. Last week we saw a stand-off between the
EU authorities and Greece’s government. Our economist’s central case remains that a
deal is done but it is going to be a bumpy ride for markets in the near term.
* …and a marked increase in bond volatility
Volatility in the bond market has added to investor nervousness, not helped by Mr
Draghi’s comments last week. Our economists think markets overreacted to this and
that the ECB has no desire to see bond yields significantly higher. Low rates and a
low euro remain key to the ECB QE programme’s success, so we see limited scope
for either to move markedly higher without the ECB coming in to calm things down.
* Markets getting oversold – risk of sharp rally on a deal
In April we said that markets were vulnerable because of the strong rally from
October of last year. With the DAX now 10% off its April high, we believe markets
offer a better risk-reward profile. Should an agreement be reached on Greece, we
would expect a sharp rally of the order of 5%. As we have said before, we see
downside risks being limited, even in the event of an “accident”, because the ECB is
able to intervene to limit the risk of contagion.
* Banks still our preferred overweight
Banks would probably be the sector to benefit most from the end to uncertainty.
Notwithstanding the drop in markets since our first note of mid-April, it has been the
best performing sector. We see it as the sector best placed to benefit from the
ongoing European recovery.
* Retain overweights in Industrials, Utilities and Oils
Industrials have also performed well since mid-April and we like it as a good value
way to play improving growth. Utilities have been mixed of late but we like the yield.
Oils have struggled since the end of April as oil prices have stalled but investors
remain heavily underweight and a rally in the sector would be a pain trade.
* Stay underweight Staples, Pharma and Autos
Our underweights in Staples and Pharma have worked, with the sectors starting to
suffer from the back-up in yields. We see them as ongoing candidates for rotation
as the recovery story manifests itself in better profit growth elsewhere. Investors
have started to wake up to concerns about over-exposure to China for German
autos and we feel the sector has more room to underperform.