Less inflation danger

Investment Policy, March 2019

Less inflation danger

Global economic growth is weakening noticeably – as reflected in figures for consumer spending, global trade and industrial production. This cooling is affecting all regions, and increasingly even the US and China. Central banks have an obligation to act, but have little freedom of manoeuvre to increase monetary liquidity. Given the economic slowdown, the inflation trend is also changing, which makes inflation-linked bonds less interesting than a mix of higher-yielding corporate and government bonds. Defensive equities that still have growth potential but exhibit less volatility than the market as a whole continue to make sense. Progress in the trade talks US-China support emerging market stocks.

It is rare for the global economy to be undergoing such a broad-based and clear economic slowdown. Figures for German industrial production indicate a year-on-year decline of 4%, while industrial orders – an important leading indicator – reveal year-on-year decreases of -7%. Whereas year-on-year growth in German retail sales stood at +4.0% in spring 2018, it had declined to +1.6% by November and is now languishing at -2.2%. In France, consumer spending is down 2.3% year on year. This is the most important part of economic activity in many countries – and not just in Europe and the US but now also in China too. 

Whereas in 2013 year-on-year Chinese retail sales growth was over 14%, it has now fallen to 8.2% – which would be impressive for most countries, but in the case of China represents a 15-year low. In the US too, consumer spending has now weakened sharply. Just five months ago, year-on-year retail sales growth amounted to +6.6% (compared to a 20-year average of around +5%), but in mid-February it was a disappointing +2.3%. It is clear that there are numerous political uncertainties around the world at the moment, including tense situations in Italy and Spain, the endless "Brexit" saga, and US President Trump's trade dispute with China (and perhaps also with Japan and Europe in the not-too-distant future). These political uncertainties are weighing on sentiment and corporate investment activity while the financial markets are looking hopefully to the Fed. But is the US central bank really prepared to do even more for the economy, i.e. cut interest rates, as the market expects will happen soon? What will/can the European Central Bank contribute to the improvement in monetary liquidity that is now required? As cutting the ECB's deposit rate is hardly an option given the current level of -0.4%, will we soon see a resumption of quantitative easing in the form of bond purchases, which the ECB has only recently discontinued? For central banks, 2019 is set to be a truly interesting year.

Positive developments in US-China trade talks could benefit our overweight in emerging market equities particularly.

Gérard Piasko, Chief Investment Officer

Equities
Equity markets are currently influenced by a balanced mix of positive and negative factors. Therefore we keep our neutral weighting of equities. On the plus side, markets are no longer confronted by the enforced reduction of monetary liquidity through interest rate increases on the part of the Fed. On the minus side, the global economy is clearly ailing. Earnings forecasts for 2019 have been reduced most strongly in the emerging markets (by more than 4%), which is hardly surprising in view of the ongoing slowdown of growth in China and other countries. A striking aspect is that the decline in earnings forecasts is similarly high in the US and Europe (some 2.5%), but only around 1.5% for the more defensive SMI. A more defensive positioning in equities with lower volatility continues to look like a sensible play in view of the economic headwinds. If trade talks between the US and China see further progress emerging market equities could benefit especially.

Bonds
The fixed-income markets are influenced less negatively by higher inflation and inflationary expectations than in 2018. A lower average oil price than last year should keep consumer price trends relatively subdued, despite higher US wages. Relative inflation stability is evident in the majority of countries, and should persuade both the European Central Bank and the Swiss National Bank to refrain from interest rate rises for the time being. Indeed, this should be the case for as long as the current economic weakness persists. Inflation-linked bonds therefore now look less appealing than a mix of higher-yielding corporate and government bonds.

Currencies
Last time we wrote that the deterioration of the European economy is not a positive for the euro. We are anticipating the existing trading bandwidth of around 1.12 to 1.16 for both EUR/USD and EUR/CHF, which dates back to autumn 2018, to continue to hold for now. However, as the publication of an array of US economic data has been delayed by the US government shutdown, volatility could increase over the next few weeks. Because the US dollar has increased in recent in the last months against the Euro and the Swiss Franc, we decided to take half of the profits in the US dollar. 

Commodities
At +14%, there has been a striking rise in US oil production since last autumn. On the other hand, the total production of OPEC member states has declined by some 2 million barrels per day, which has more than compensated for this increase. After a dramatic collapse in the fourth quarter of last year, the oil price has bounced back by more than 20% since the start of the year, and appears to be on an upward trajectory. Gold has now reached the technical resistance zone of USD 1300-1350 per ounce that we referred to last month. It remains to be seen whether the recent pick-up in demand for gold as a safe haven is stronger than the very real possibility of profit-taking in the event of a partial resolution of the trade dispute between the US and China. 

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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This publication is intended for information and marketing purposes only, and is not geared to the conclusion of a contract. It only contains the market and investment commentaries of Maerki Baumann & Co. AG and an assessment of selected financial instruments. Consequently, this publication does not constitute investment advice or a specific individual investment recommendation, and is not an offer for the purchase or sale of investment instruments. Maerki Baumann & Co. AG does not provide legal or tax advice. In addition, Maerki Baumann & Co. AG accepts no liability whatsoever for the content of this document; in particular, it does not accept any liability for losses of any kind, whether direct, indirect or incidental, which may be incurred as a result of using the information contained in this document and/or arising from the risks inherent in the financial markets.

Editorial deadline: 26 February 2019

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