Back in high school, your status depended upon your ability to hang with the cool kids. Turns out that the situation is much the same when it comes to national economies.
This week, China and Greece find out more about their membership in semi-exclusive fraternities. Depending upon which way the social decisions go, markets could react just like adolescents everywhere – with more emotion than thought.
The fun begins on Tuesday, when China discovers if its A-shares – that is, Chinese stocks listed in mainland China – are allowed to sit at the same lunch table as other emerging market stocks within the MSCI benchmarks used by investors around the world.
If A-shares are added to the MSCI Emerging Markets Index and MSCI All Countries World Index, global portfolio managers are likely to interpret the move as an endorsement of Chinese stocks. That, in turn, could add to the groupie-like frenzy at the Shanghai Stock Exchange, which has already surged nearly 70 per cent over the past six months.
The MSCI indexes pack such powerful clout because they're widely used as benchmarks by professional investors and exchange-traded funds, especially when it comes to emerging markets.
At the moment, so-called H-shares – Chinese stocks listed in Hong Kong – are China's only representatives in the indexes. The H-shares make up a scant 3 per cent of the world index and only 25 per cent of the emerging markets index.
Given the massive size of China's economy, many investors believe that Chinese stocks are woefully underrepresented in the indexes and that it's vital to expand their role.
The pro-China opinion, however, is far from universal. By many measuring sticks, the Shanghai stock market is a bubble. It trades for more than 25 times earnings – well above the level in North American markets – and it has been going up like a rocket in recent months, despite a slowing Chinese economy and widespread concerns about the country's porous accounting standards. Adding A-shares to market benchmarks at this point would seem to amount to a deliberate embrace of frothiness.
However, there's also the matter of competitive pressure, according to economists at Bank of Nova Scotia. They note that Vanguard, the huge U.S. money manager, just announced that A-shares will be included in its emerging markets ETF. Given that move, it may be tough for MSCI Inc., purveyors of the MSCI indexes, to say no to including the shares in its own products.
In Europe, meanwhile, the in-crowd is saying nothing but no. All the kids are doing it: Greece says no to its creditors' demands for pension reform and labour market overhauls; the creditors say no to Greece's demands for debt relief and easier borrowing terms.
The battle of the no's has been going on for months but appears to be drawing to a resolution that will determine whether Greece stays in the euro club. While default wouldn't necessarily mean that Greece would leave the currency group, it would raise the probability of so-called Grexit to extremely high levels.
Its departure would call into question the supposedly irrevocable nature of the euro project and raise questions about which country would be the next to exit. That uncertainty, in turn, would scare away investors, drive up borrowing costs and endanger the continent's feeble recovery.
This past week, Greece delayed a €300-million ($414-million) loan repayment to the International Monetary Fund. In response, Greek stocks plunged on Friday, with the country's three big banks all losing 10 per cent or more in share price.
The steady stream of withdrawals from Greek banks suggests that the impasse cannot go on much longer. "It's been said many times but the clock really is ticking," writes Jonathan Loynes of Capital Economics.
He sees reasons for optimism. Greece's main creditors have narrowed their differences and put a common set of proposals in front of Greek Prime Minister Alexis Tsipras. Greece, in turn, has presented its most comprehensive plan yet for long-term debt reduction.
The problem is that Greece's plan proposes that other countries agree to forgive half the €53-billion of loans they made to Athens during the country's first bailout in 2010. The plea for a massive writedown isn't likely to go down well among other euro zone member states that have endured years of austerity.
"We are nervously maintaining our base case scenario that some form of short-term deal is cobbled together which … keeps Greece in the single currency union for a few more months at least," Mr. Loynes writes. "But the risks to this scenario are high and rising."