GI Research Market Commentary Early agreement sends Greek assets to multi-year highs Yesterday, the Greek government reached a preliminary agreement with the Institutions to end the second review of the third bailout program. The Greek government agreed to cut pensions, broaden the tax base and liberalize the energy market. No major concession was offered, as Greece will be allowed to approve offsetting expansionary measures only in the case of budget outperformance. The Greek parliament is expected to approve the agreed measures by May 18. This would clear the way for the disbursement of the next aid tranche at the next Eurogroup meeting on May 22, allowing Greece to meet its large July debt redemptions. Greek sovereign yields and spreads fell to the lowest levels since September 2014, while the Greek equity market hit the highest level since capital controls were imposed in late June 2015. Valuations look somewhat stretched in the near term with most of the positive news already discounted. Further gains remain dependent on a more solid economic recovery and the future negotiations over Greek debt relief. The latter could eventually lead to the inclusion of Greek bonds in ECB s QE program, starting not earlier than in August this year. Yesterday morning, the Greek government and European authorities reached a preliminary agreement over the completion of the second review of the third bailout program. The conclusion has been delayed for almost six months amid the refusal by the Greek government to undertake additional austerity measures to ensure the achievement and the sustainability of the primary surplus target of 3.5% of GDP. As we described in our Focal Point Greece: No deal yet, but 2015-style crisis unlikely (released on March 24, see here), the Greek government failed to secure major concessions and eventually agreed to Institutions requests on all the major topics: Greece will cut pension expenditure in 2019, a year before than originally planned in order to reduce implementation risk (the next Greek general elections should take place no later than in October 2019). The government also agreed to undertake measures to broaden the tax base. This includes the reduction of the tax-free threshold from 8,636 to 5,500-6,000 and possible cuts to several tax breaks. These measures, coupled with pension cuts, will sum up to 2 pp of GDP. Athens also agreed to accelerate the liberalization of the energy market in order to increase competition. The state-owned Public Power Corporation will sell around 40% of its lignite units and coal mines. Greece will be allowed to approve offsetting expansionary fiscal measures only if budget execution exceeds the targets (primary surplus of 3.5% of GDP in 2018). PM Tsipras also failed to secure a quantifiable target for debt relief. With the IMF and European creditors still far from a common solution on the issue, no clear commitment has been made on the measures to ease Greece s public debt burden. The Institutions are however expected to resume talks over debt relief soon after the conclusion of the review.
According to a few government spokesmen, the Greek parliament where the left-wing SYRIZA holds a thin majority with its junior ally ANEL is expected to approve the agreed measures by May 18. This should clear the way to the disbursement of the aid tranche at the next Eurogroup meeting on May 22. The disbursement of the aid tranche will allow Greece to meet the 7.1 bn debt coming due in July. Greek assets rallied markedly following the news of the progress in the negotiations. On the bond side, the yield of 10-year Greek government bonds fell by more than 30 bps to around 6%, the lowest level since September 2014. Similarly, the spread over the German Bund declined to 570 bps, exactly half the level hit during the global financial market turbulence in February 2016.
Further spread tightening remains possible in the near term should the deal be finalized and no major negative event (e.g. a surprising victory by Le Pen in the French presidential run-off) emerge in global financial markets. That said, a more sustainable decline in risk premiums requires a comprehensive deal on debt relief in order to facilitate Greece in regaining the market access. An improved debt sustainability profile can persuade the ECB to include Greek bonds in its QE program, with the first purchases being feasible after the repayment of the bonds owed to the ECB maturing in July (worth almost 3.9 bn), i.e. when ECB s holdings will fall again below the 33% issuer limit. Also Greek equities rose strongly, with the Athex Composite Index up by 3.1% yesterday to the highest level since the imposition of capital controls in late June 2015. After the recent rally up by around 15% in the last six weeks compared to a 4-5% increase for the MSCI EMU the Greek market shows a 12-month forward PE which is above its historical average by nearly 20% (15X, the MSCI Greece) and slightly more stretched than in the case for the euro area (EA). Indeed, the MSCI EMU deserves the same PE level as for Greece but with an overvaluation versus its own history at a more limited 15%. The recent move in Greek equities was largely driven by the decline in Greek government bond yields. That said, earnings forecasts have stopped declining in relative terms versus the EA since one month or so and have started to move slightly upward (+5% vs EA), after having reached a long-term historical bottom.
Equity valuations are not cheap at the moment but mid-term they could continue to be supported by low spreads and improving earnings estimates. That said, the Greek index remains strongly sensitive to negative exogenous risks (French elections, higher core rates, geopolitical frictions). Of course, future discussions concerning debt relief measures will be at the center of investors focus and will also represent a key source of volatility. The latter has scope to reach very high levels (25% in the last year, the highest volatility globally together with the Italian FTSE MIB) as the beta of the Greek index is very high (1.5 vs. the MSCI World) due to its large weight on banks. In sum, while fully recognizing the new better environment for Greek assets, we turn more cautious on Greek equities short term, recommending a neutral position in an equity diversified portfolio.
Authors: luca.colussa@generali-invest.com Michele.Morganti@generali-invest.com