Greek Referendum: The Impact for Investors
The outcome of the referendum in Greece on Sunday will likely have an impact on asset markets in the short term. We believe that a "yes" vote is the most likely outcome. This would support our positive view on equities and negative view on fixed income in Europe.
In our base case, where the Greek population votes "yes" to the referendum, we might see a relief spike in the EUR on the perspective of a definitive Greek solution ultimately being found. Over time, however, and once the Greece risk is "priced out," markets are likely to refocus on the ECB's quantitative easing (QE) policy and its negative impact on the EUR, particularly against the USD, as US policy is likely to normalize. EUR/CHF would likely find some initial support as well, although we expect only limited gains, as absolute and risk-adjusted yields spreads are still narrow. In the unlikely event of a negative Greek outcome with a "no" vote, markets would add a risk premium to EU assets, and we could see large scale outflows, which would weigh on the EUR. In this case, EUR/CHF would likely re-test the 1.03 level, in which case we think the Swiss National Bank would stand ready to intervene again, similar to the episode seen at the beginning of the week.
Credit Risk Contagion Contained in Europe
Notwithstanding the developments around Greece, the risk-off move was relatively contained this week. US Treasury yields actually increased slightly, and a further improvement in US economic surprises would support higher Treasury yields. In Europe, the ECB's QE program has not prevented peripheral spreads from widening, but it has ensured that sovereigns maintain market access at relatively low rates, with this week's 5-year Italian and Spanish issues, for instance, being well received. This, combined with better economic prospects, makes a repetition of the European sovereign downgrades observed in 2011–2012 very unlikely, in our view. Nevertheless, we still expect volatility to prevail in the European fixed income market, with US Treasuries still seen as a short-term natural hedge in the event of a negative outcome. However, if the referendum is accepted, initial market reactions are expected to be negative for benchmark government bonds and positive for the periphery and credits in general, especially for European high yield bonds, where peripheral exposure is significant. In both cases, we see contagion risk stemming from the Greek banking system as rather limited.
Large Issuance Volumes to be Expected in Case of a "yes"
Despite the relative resilience of credit spreads – supported by Thursday's announcement by the ECB that it would include non-financial public sector corporates in its QE program – the current environment has weighed on the corporate primary market, with a number of planned issues pulled by issuers. In the event of a "yes" outcome to the referendum and a subsequent agreement between Greece and its creditors, we would expect there to again be large issuance volumes in the markets, which could render a spread tightening rather unlikely over the coming months, in line with our negative relative view on investment grade corporates and neutral stance on high yield bonds. All the same, a "yes" outcome to the referendum could potentially also lead to political change, making an immediate deal difficult, and the market could start focusing on the upcoming redemption of Greece's Samurai bond on 14 July, for which a missed payment would most likely trigger a cross default after the passing of the usual grace period.
Greece Moved Markets in Both Directions
In a volatile week, equities lost ground ahead of the Greek referendum on Sunday, although losses were limited. Eurozone equities underperformed the most and lost 3 percent. However, there was no clear trend, as Greek news flow moved markets in both directions throughout the week. More defensive markets, such as the USA and Switzerland, held up better. On the sector side, defensive sectors outperformed as uncertainties remain high. Energy was the weakest performer in a week when the oil price sold off. Moving on to next week, the outcome of the referendum on Sunday will be important in the short term for our positive view on Eurozone equities. A "yes" vote, which is our base scenario, would likely trigger a rally in European equities, with Greek domestic stocks and periphery markets likely to outperform the broad Eurozone market. In case of a "no" vote, we think that the initial reaction would be negative for Eurozone equities. But fundamentals would likely remain positive, and ECB support to the periphery would quickly put an end to any risk of a sustained sell-off, in our view. A weaker EUR, a likely outcome in such a scenario, would also partially offset the loss for non-hedged international investors.
Earnings Season Kicks Off in USA Next Week
Next week also sees the unofficial kick-off for the US Q2 reporting season when Alcoa publishes its results on Wednesday. PepsiCo and Walgreens – two large consumer staples companies – are set to report on Thursday. This will provide some insight into the sector's performance in the second quarter. The week of 20–24 July will be the most important one in terms of earnings releases, as 35 percent of the S&P 500's market capitalization is slated to release their numbers for Q2. In the Eurozone, the peak of the Q2 2015 reporting season is one week later. More than half of the Euro Stoxx's market capitalization publishes results in the last week of July. We expect companies from the Eurozone to do well again, as they are benefiting from the ongoing economic recovery as well as a currency tailwind. Equity fundamentals remain strong in the region, which is the main reason why we turned positive on the Eurozone last week despite continued uncertainty in Greece.
Gold Fails to React to Greek Troubles
Gold has failed to live up to its reputation as a safe haven yet again. With an average volatility that is higher than that of equities, gold's reputation as a safe haven might be overstated. In any case, despite renewed uncertainty surrounding Greece in recent weeks, gold prices have been slipping. Investment flows show some short-covering activity and very little fresh long interest in high-frequency data. Instead, investors have been focusing on the prospects of Fed rate hikes and renewed USD strength, which appear to be offsetting fears of market turmoil. Indeed, contagion risks from an adverse Greece scenario are much more contained this time around given the reduced involvement of foreign investors. At the same time, central bank asset purchase programs have reduced the default risks of higher-risk securities, against which physical gold used to serve as a hedge (particularly in portfolios with low credit quality). Neither jewelry markets nor central bank demand is sufficient to compensate for the lack of investor interest at this stage. As a result, we still see gold as vulnerable to further losses, expecting USD 1100 in 3M and USD 1000 in 12M. Gold in EUR and CHF should suffer less than in USD-terms but still, we do not consider it a good investment in the current environment (other than holding a very small portion of roughly 1 percent in a diversified portfolio). For investors already holding gold, we would consider selling into any rebounds. As implied volatilities are near multi-year lows, selling options is not particularly appealing at this point as either strikes will be close or yields small. Instead, we would look to buy volatility as prices appear to be approaching a major support zone at USD 1140/30 (2014 lows) where a break could trigger accelerated unwinding.