COMMODITIES SELL OFF AND GREECE – WHY IS IT SO IMPORTANT?

'Greece' was the word in financial markets in the month of June with declining commodities markets and Chinese stock market collapse taking a secondary seat. We expect commodities and China to gain more attention in July but Greece will dominate near term. The unexpected Greek referendum will effect asset valuations the world over. The market has always assumed an 11th hour Greek deal would be reached but in the ruling far left Syriza, they are taking a very large gamble. We think the risks are significant and vastly underpriced and a‘’Grexit’’ would add huge volatility to markets, being negative for risk assets and positive for bonds.

If Greece is allowed to write down their 325 billion Euros of debt, other heavily indebted nations will follow requesting similar relief. Austerity in these countries has been brutally painful giving rise to anti austerity left wing politics from an angry public, looking for champions to fight financial oppressors (creditors who would like to be repaid – funny old world). With elections in Portugal in September and Spain in December, Europe is rightly reluctant to offer debt relief (write downs) to Governments who shy away from the financial responsibilities of their predecessors. It sets a dangerous precedent that will find no end and would attack domestic banking systems causing financial contagion. We don't think an 11th hour deal is so simple this time round.

Greece’s ruling Syriza want debt relief, knowing ejection from the Eurozone will be dramatic and painful, but a deal with creditors on current terms continues painful austerity viewed as an equally bad alternative. The chances of an emotional accident are significantly higher than markets currently prescribe.

Greece is the first nation to come to the end of their mountainous debt highway – many others will follow. The world has immersed itself in high levels of debt with the public showing a casual indifference as politicians have run huge structural budget deficits (let the good times keep rolling – debt financed if need be). Households have also enjoyed debt financing, borrowing at a record pace. The centralized response to the GFC was to create more debt, with global debt now 50% higher in nominal terms than pre GFC levels. Economic growth has become debt financed, not organically driven. Add to this Quantitative Easing (printing paper money), and we have created extra demand out of thin air. However, all the existing and newly created debt requires servicing to make the mathematics of debt solvency and sustainability workable. Relief comes in the form of Zero Interest Rate Policies making debt extremely cheap to finance. Global asset markets have traded to record highs with 83% of global equities markets being currently supported by a Zero Interest Rate Policies, living on cheap debt oxygen.

So why is Greece important in all of this? In the short term a “Grexit’’ will add significant volatility to markets which hate uncertainty. We would expect risk markets of credit and equities being negatively affected as the Greek banking system becomes insolvent almost instantly without significant ECB support. Whilst this has captured the majority of attention over June, also note Chinese equities are down over 25% from mid-month peaks and commodities have started to resume their bear market sell off. We will follow these market themes closely in July.

FUND HIGHLIGHTS & POSITIONING

JAMIESON COOTE BONDS ACTIVE FUND DECLINED 0.18% GROSS IN THE MONTH OF JUNE. THE MOMENTUM SELL OFF IN BOND MARKETS CONTINUED IN JUNE WHICH WE SEE AS OPPORTUNITY TO ADD DURATION TO THE PORTFOLIO.

Markets focused on timing and speed of potential FOMC rate hikes in the US which we believe will not materialize until 2016. Greece also dominated headlines with market optimism remaining that an 11th hour outcome would materialize. After trading cautiously early in the month with low duration, JCBAF added duration mid-month as valuations improved and Chinese equity markets broke trend line supports opening significant potential downside. This was also aligned with commodity complexes rolling over to renewed bear market pressure which is very constructive for bond markets mid term. JCBAF held its largest average duration position since the fund’s inception at 5.03 years in June, and despite markets finishing lower on the month, we were able to significantly outperform the market sell-off by 106 bps thanks to headline volatility around the Greek situation providing excellent trading opportunities intra month.