The Weekly Update

Last week Greek 2 year bonds touched yields of 9.5% on the back of a disenchanting report from the IMF which has revived a dispute between the IMF and EU creditors. Europe and markets generally have continued to assume that the IMF would eventually join the third bailout programme for Greece which for the last three years has fallen solely to the European Stability Mechanism (ESM). The IMF was meant to have decided on their participation by end 2016 but continue to abstain whilst arguing for a 1.5% primary surplus – rather than an “unrealistic” 3.5% target by 2018 as demanded by the European Commission – which would necessitate significant debt relief from other Eurozone countries.

With €7bn of debt due in just 5 months another bailout will need to be reached before then and this latest spat clearly makes this more difficult; bear in mind just how little consensus has been reached in the past 2 years of negotiations. German officials have warned that without the IMF the entire rescue programme would be axed. With government debts already at 180% of GDP the IMF forecast that this debt load would turn “explosive” after 2022.

Those disputing IMF’s concerns say they have yet to fully factor the most recent improvements in the Greek economy which have been notable on the back of increased tax revenue and expectations that the economy will grow above 2% this year for the first time in a decade; that is of course after real output dropping by over a quarter since the crisis and having ebbed at this nadir for past 2 years. Greece is of course already 8 years on, so many hope it is about time for some recovery. But just because its economy has stopped shrinking does not give proper cause to believe it is assured a long term trend of growth. There are few promising opportunities on the horizon for Greece in the face of unemployment, depressed domestic spending, global secular stagnation and little in terms of policy in the pipeline that would be a boost.

One of the issues again being discussed is the risk of redenomination of Greek debts is the case of a Grexit and reinstated drachma. This of course would no longer be the preferred option for Greece itself (perhaps regaining monetary sovereignty in order to inflate debts away would have been the best option back in 2010 but that opportunity was missed). As numerous as the concerns are for Greece this is perhaps less of a concern for Greek international debt which mostly follows English law. So if the European Project does fall apart at least those holding Greek debt would get whatever funds they can recover back in euros. We of course remain averse to almost all European government debt either for lack of value or excessive and under-priced risk. A decade ago when Greece was still A1 rated and could borrow at 1% for 2 year and 4% for 10 year debt we were warning of their excessive Net Foreign Debts. Following adoption of the euro Greek debts ballooned – lured by markets wrongly associating the various euro denominated government debts.

We prefer to hold a positions such as the US company, Southern Copper Corporation across our global bond fund products. Headquartered in Phoenix Arizona with mining activity predominantly undertaken in Peru and Chile the US dollar denominated 7.5% 2035 issue has performed extremely well and is one of the few bonds currently trading above the Trump election sell-off back in early November. This bond has rallied nine points since the election and continues to offer attractive risk-adjusted value. Currently trading at a spread of around 300bps off of US Treasuries, this BBB/BBB+ rated bond remains about 4.3 credit notches cheap against its RVM fair value spread of 145bps and equates to an expected return and yield of 22.3% should it move to fair value. Of course the 5.6% yield is a welcome addition to any portfolio.

We continually search for rotation candidates across our portfolios as some names move faster than others, or indeed individual companies/Government issuers are affected by their own characteristics such as further supply or news affecting profits. However, it is challenging to find a candidate to rotate into from our Southern Copper holding which still offers so much on a risk/reward basis currently.