Investors who have focused on the short-term worry created by Greece’s tense standoff with its eurozone partners have missed a number of positive factors that hint at a much stronger future, according to Jim Wood-Smith, head of research at Hawksmoor Investment Management. 
After a rollercoaster series of negotiations, Greek prime minister Alexis Tsipras agreed to accept stricter austerity conditions in return for a third bailout package. This was passed by the Greek parliament yesterday, but the International Monetary Fund has warned that the country needs further debt restructuring if it is to avoid future difficulties.
Wood-Smith (pictured) argues that the situation in Greece “will only temporarily affect markets” and even welcomes the sell-off it prompted as it has brought the valuations of stocks and bonds to more realistic levels.
“[The Greek debt crisis] is disguising a marked improvement in much of the world economy over the past three months,” he said in his latest update.
“Indeed, having been so concerned in April that equity markets were in danger of running too far ahead of themselves, we positively welcome Greece’s role as the party pooper. Having been ahead of themselves three months ago, both bond and equity markets now have much firmer foundations.”
Performance of indices over 2015
Source: FE Analytics
With these “firmer foundations” now being seen in markets, Wood-Smith highlights four pieces of positive news that could be supportive of further growth in the time ahead.
UK firms and economy in rude health
While maintaining political neutrality, Wood-Smith says the Conservative victory in the general election was “undoubtedly the best result for the markets”. The FTSE rallied on the news that the party will form its first majority government since 1997.
This comes as the UK continues to post healthy economic numbers. According to the Office for National Statistics, UK GDP grew by 0.4 per cent in the first quarter of the year, while the unemployment rate stands at 5.6 per cent, down from 6.5 per cent one year earlier.
“In the UK, with the notable exception of the oil industry, the majority of companies have reported consistently encouraging profits,” he said. “Whilst pleasing, this has also surprised us and points to the UK economy having rebounded strongly from a brief dip before the general election.”
Performance of index over 1yr
Source: FE Analytics
Eurozone recovery was strong before QE
Europe has been much in the headlines over recent months. Firstly because of the positive news that the European Central Bank decided to launch a €1.1trn quantitative easing programme to stave off deflation and spark economic growth.
Then, of course, came before Greece’s problems and threat that the beleaguered nation could be forced to leave the eurozone. Although there has been the hint of a resolution from the bailout deal, commentators have pointed out that it is not yet set in stone and could still be derailed.
Wood-Smith says much improved economic growth in the eurozone was one of Hawksmoor’s key expectations for the year, regardless of whether the central bank launched quantitative easing or not, as indicators such as a sharp increase in money supply suggested this was coming.
Figures from European Union statistical office Eurostat show that GDP grew by 0.4 per cent in the eurozone over the first quarter of the year, house prices rose by 0.9 per cent over the same three months and the unemployment rate is the lowest since March 2012 at 11.1 per cent.
But this doesn’t mean Europe should just be seen as a central bank play. Wood-Smith added: “The improvement in many eurozone economies has happened before quantitative easing has even had a chance to take effect.”
Bond market inefficiency can be exploited
Recent months have been especially testing for bond markets, as the launch of quantitative easing in Europe coincided with a brief period of deflation. These combined to create “temporary insanity”, where the yield on 10-year German bunds dropped to a low of 0.03 per cent.
However, deflation appears to be a receding threat after the oil price – which had spent the second half of 2014 in freefall – stabilised and started to drop out of the annual inflation calculation, just as growth picked up. Wood-Smith thinks this could have created opportunities for nimble bond investors.
Performance of oil over 1yr
Source: FE Analytics
“The more recent realisation that deflation was a temporary phenomenon of the oil price and that economic growth was increasing has seen a small outbreak of rationality. That said the yield on the 10-year bund is still less than 1 per cent. This might seem a miniscule change but it has dumbfounded a number of the largest bond fund managers in the world,” he said.
“These managers operate ‘models’ that are based on percentage rather than absolute changes in yield and were amusingly unable to cope with a rise from 0 per cent to 1 per cent. It encourages us greatly that the cleverest brains in the business can be so hopelessly wrong-footed. This is not because of any intellectual challenge but because it ensures that markets will remain inefficient. And what the computers get wrong creates opportunities for others.”
Renewed strength of US housing
Wood-Smith says the recent strength of the US housing market “has come somewhat out of the blue” and should be seen as encouraging – even if it does make the Federal Reserve more likely to lift rates.
“After a notably lacklustre start to the year, the level of residential construction activity in the United States has improved remarkably in April, May and June. This has been matched by similar pickups in sales of both new and existing homes and should presage much higher levels of job creation over the second half of the year,” he said.
“This will not be lost on the Federal Reserve in its deliberations over when to raise interest rates and we still expect the first increase to come before the year end.”
One downside for the US, however, is the strength of the dollar, which has rallied hard in the expectation that the US will be the first major economy to boost interest rates.
Rest of the year?
Looking forward over the rest of the year, Wood-Smith says he has more confidence than he did three months ago thanks to the volatility that has just been seen.
“The falls in global equities and the rises in many bond yields have created a much more sustainable situation than the heady days of the first quarter. Although it is still slim, the margin of safety has increased,” he explained.
“The second half of the year will bring higher, but still very low, inflation and the prospect of the first step in a very gradual series of interest rate rises. Markets will need to adjust to these, but are now well placed to do so.”
