It’s only been a month since our post on year-end sector rotation where we discussed the high short interest in two funds representing two highly dissimilar scenarios, the Global X FTSE Greece 20 ETF (GREK) and Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR.) Since December 8th through the close on Friday, ASHR tacked on another 7.47% gain while humble GREK dropped 27.25%. Given the very different conditions facing these two nations, it reminded us at ETFG of one of Sir John Templeton’s famous quotes: “People are always asking me where the outlook is good, but that’s the wrong question…. The right question is: Where is the outlook the most miserable?”
It was also only a year ago that the markets’ concerns weren’t on whether the EU would survive but whether China might be about to experience its own “Lehman Moment.” Driven by the need to meet mandated GDP targets through infrastructure investments even as official lending standards were being tightened, off-balance sheet investment trusts had experience phenomenal growth but were looking increasingly insolvent. Concerns over the state of China’s finances, or the sustainability for high single digit GDP growth were nothing new and the main H-share benchmark, the Hang Seng China Enterprises Index, had been punishing investors for years thanks to its large allocation of Chinese bank stocks. Between January 1, 2011 and its low on March 20, 2014, the index had declined nearly 27.49% compared to a 48.85% rise for the S&P 500.
It was in that March that Bloomberg noted that the average P/B ratio of the 4 largest mainland banks traded in Hong Kong had dropped to .94, indicating investors had begun to fear the possibility of equity restructuring if not outright nationalization. Fast forward a year and the situation has changed radically; thanks to a series of confidence inspiring moves including easing reserve requirements and direct capital injections, China’ s largest lenders are again trading at P/B ratio’s above 1 while the Hang Seng China Enterprise Index is up over 31.27% since its low on March 20th.
Switching back to Europe, concerns over the future of the EU project had already led to a punishing six months for the Currency Shares Euro Trust (FXE), now back to 2005 levels while the political situation in Greece seems to only go from bad to worse. In 2012, it was a challenge from the far-right with Golden Dawn, in 2014 the threat to the status quo is coming from the far-left where the Syriza party led by Alexis Tsipras seems poised for victory on a platform built around the need to write-down existing debts while alleviating the on-going fiscal austerity that has been mandated as part of the ECB/IMF led bailout. Polls at the start of January showed Syriza with a commanding lead and have sparked reports that Germany is quietly preparing for a Greek exit from the EU. With that backdrop of more uncertainty after the election and a possible “Grexit”, is it any wonder that the only Greek-related ETF available to U.S. investors, with a 30% allocation to Greece’s largest banks, is now trading at a P/B ratio of .41 according to parent Global X? Investors are clearly prepared for the worst.
But before investors brace themselves for seemingly apparent collapse of the Eurozone, there are several major events due before the Greek presidential election on January 25th. As Gavyn Davies outlined in the January 7th FT, the next few weeks could be critical to the success of failure of the great EU project beginning with a potential opinion from the European Court of Justice on Germany’s challenge to the ECB’s Outright Monetary Transaction program, begun in 2012 as part of his “whatever it takes” campaign that has yet to be used. Davies notes that, spoiler alert, the Court of Justice has shown an inclination towards favoring programs that reinforce European integration, but even then Germany will only take their opinion under advisement. Next is a potential QE announcement from the ECB on January 22nd as low inflation becoming deflation seems to be giving the ECB the cover necessary to start a QE-like program. Greek voters will be watching both of those developments closely before their election and volatility is sure to remain high heading into the election, where the lead held by Syriza narrowed slightly in recent polls.
While the challenges facing Greece are far different from those that beset Chinese investors, it would be hard to find a situation that better fits Sir John’s maxim to invest where uncertainty and doubt rule the day. However, the question remains to be answered whether investors will be rewarded for enduring another Greek drama.
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