Rising interest rates pose the chief threat to bourse recovery
The Athens bourse has turned out to be a better predictor of future economic conditions in the last few years than the complaining average Greek household, but one wonders whether this link has been damaged by the recent sell-off. To a large extent, this depends on whether the current drop is just a sharp, short-term correction or the beginning of an era of weakness and underperformance vis-a-vis its peers, which will be mirrored in GDP growth rates a year from now. The Greek average retail investor has not been fond of equity investing, for a good reason. For many of them, their first encounter with the Athens bourse took place during the 1999-2000 period when stock prices were at historically high levels that were not justified by company fundamentals and valuations. The ensuing bursting of the bubble resulted in huge capital losses and appears to have left a lasting scar on their investing behavior ever since, making them more risk-averse even if it meant putting their money in repos and other bank deposits that earned them less than inflation. Being a large fish in a small pool, global funds investing in emerging markets have had sizeable positions in Greek stocks which they were forced to liquidate during that period. The ensuing underperformance coupled with the growth recession in the US and the worldwide bear market did little to stop the slide of the General Stock Index of the Athens bourse to about 1,700-1,800 points in 2002 and early 2003. But the seeds of economic and market recovery planted earlier by the central banks of the major economic powerhouses started bearing fruit as abundant liquidity continued to push real interest rates (that is, the difference between nominal interest rates and inflation) close to zero and even into negative territory in countries with relatively high inflation such as Greece. Cheap valuations and the prospect of earnings upgrades started bringing more and more large companies listed on the Athens bourse to the radar screens of an ever-increasing number of foreign funds. This process pushed the local market to levels not seen since 2000 a few weeks ago, and helped it outperform most of its peers in the league of developed stock markets. The local large caps, namely banks, which led the charge, benefited from strong revenue growth rates at home, supported by a strong economy, cost containment and the drive to expand eastward in neighboring markets. Greek vehicles The Greek companies with an increasing exposure in the Balkans offered a good investment vehicle to do so. But the hunt for superior returns in emerging markets can turn into a nightmare for a jedge fund which has not taken steps to protect its portfolio via derivatives or other techniques. Hedge funds and traditional funds investing in European small-caps found this out when the prospect of more US rate hikes in view of higher inflation readings prompted a significant drop in risk appetite, which hit risky asset classes such as emerging markets and European small-caps the hardest. The Greek market along with the Austrian stock market felt it the most among the developed markets because of their high correlation with the risky asset classes. But, having undergone a sharp and painful correction in a month’s time, one wonders whether this is just a short-term phenomenon or something more permanent which signals worse times ahead, adversely affecting the Greek economy along the way. The easy answer is simple. It is too early to tell but it looks as if it is more like a worldwide correction with some local and regional spice. In the Greek case, the local spice is provided by the 3.0-billion-euro rights issue of the National Bank of Greece. Higher risk premium The increase of nominal interest rates worldwide supports the case for higher real interest rates and risk premium demanded by global investors when investing in risky assets from now on. Moreover, it implies that part of the monetary accommodation provided by the major central banks in past years is gradually being withdrawn, further supporting the drop in risk appetite. This should make institutional portfolios, using leverage plays such as hedge funds, more careful. Under these circumstances, the sharp drop of the Athens bourse is unlikely to turn into a sustainable rally in the months ahead, even though the disappearance of adverse local factors may give way to a relief rally which will return it to higher price levels in the next couple of months. So, since the main driving force behind the Athens bourse’s recent sharp drop is liquidations by international funds prompted by concerns about higher interest rates on the back of a pickup in inflationand a developing economic growth scare, it would be a mistake at this point to call its downturn a bad omen for the Greek economy in the quarters ahead. After all, these liquidations contrast with the recent, successful IPO of the Postal Savings Bank, which showed there is still appetite for Greek stocks at reasonable prices. Moreover, the relatively small impact of the stock market’s drop on Greek households’ wealth means there will be negligible impact on private consumer spending. In addition, the strong increase in private investment spending underpinning the 4.1 percent year-on-year growth in the first quarter appears to depend more on other factors than on the bourse. Of course, the behavior of the bourse affects business sentiment, but the recent drop has yet to eliminate sizeable capital gains made in the previous 12 months in most cases. Having said all that, one should not underestimate the importance of more ECB interest rate hikes down the road on the Greek economy and the stock exchange. In our opinion, this possibility represents the greatest threat to the bank-dominated Athens bourse and the Greek economy. The good thing is that it will most likely not be noticeable before the official ECB rate goes above the 3.0 percent mark. The bad thing is the transmission mechanism has been working since March and the signs of fatigue will start becoming more visible before the end of this year.
