Limited long-range view in the financial markets – unlike in the mountains 

Investment Policy,  February 2020

Limited long-range view in the financial markets – unlike in the mountains

The long-range view in the financial markets is not quite so crystal clear as it is in the mountains. Since visibility is poor, volatility is heightened. The reason for this is the lack of clarity over the duration and extent of the growth slowdown caused by the spread of coronavirus. In our last Market Comment, we estimated an impact of some -0.5% to -1.5% for Chinese economic growth compared to the previous year, depending on the duration of the problem and for the global GDP growth by around -0.25% to -0.5%. Due to the lack of a clearer long-term picture, it is perhaps not a bad idea right now to retain a more defensive stance with reduced volatility, at least until the fog starts to clear in the markets. We are continuing to overweight investment-grade bonds in preference to high-yield bonds, along with a slight dollar overweighting on the currency front, a regional overweighting of US equities and a strong overweighting of equities with below-average volatility.

Global economic growth may not appear to be exhibiting any decline yet, but that could well change. Up until now, the majority of banks have reduced their growth forecasts for China just slightly, based on the assumption that the phase of lower production and weaker retail turnover will be only temporary. The question of “how temporary” is important, however, as is the issue of Chinese transparency over the spread of the virus. This issue aside, the economic situation is pretty much as it was – a tour across the various countries and continents reveals the same sort of picture as it did a few months ago. In Europe, various economic data are once again disappointing, particularly in Germany. Switzerland is holding up relatively well. Thanks to robust consumer spending, things look even better from an economic perspective in the US. Over in the emerging markets, China is taking the path of moderate stimulus to counter the weakness caused by the virus outbreak. The extent to which other countries will be economically affected remains unclear because the virus remains impossible to predict. 

Company results reveal that corporate America fared better in the previous quarter than expected. What’s more, earnings growth in the US once again surpassed its European counterpart, above all because the earnings of tech companies have turned out better than expected. This can be seen as a positive factor for the trend of global equity markets, compensating the fairly nega-tive repercussions of coronavirus for 2020 economic and earnings growth at least it did for weeks. Nonetheless, we are currently anticipating historically below-average corporate earnings growth for 2020. That said, earnings growth really should improve this year given the comparative basis of 2019, when virtually no earnings growth was recorded. It is only logical that the sectors less dependent on China currently exhibit less risk of down-grade by the analyst consensus when it comes to their 2020 earnings outlook. As the recent interest rate cut by the Chinese central bank showed, the key central banks are prepared to supply the financial markets with even more liquidity when faced with more worrying economic risks. However, the Fed has more freedom of manoeuvre to cut rates than the ECB or the SNB given the already negative interest rate levels prevailing in Europe.

With so many analysts being positive on the euro at the start of the year, we are not that surprised by its decline.

Gérard Piasko, Chief Investment Officer

In the event of a rise in economic risks, the European Central Bank would probably have to resort once again to quantitative easing (QE) – the purchase of bonds to support the economy. This would have the result of boosting both bond prices (directly via greater demand from the ECB) and equities. In this scenario, lower bond yields would make equities relatively more attractive from a valuation standpoint. However, as the ECB’s leeway to purchase the government bonds of core Eurozone countries has become increasingly limited, it would come as no surprise if the volume of corporate bond purchases were to increase. This could in turn boost demand for corporate bonds of investment 
grade quality.

At the turn of the year we warned of the downside risk to the euro. As the consensus of banks and analysts was very positive for the euro at the start of the year (and for the most part still is) the sharp decline of the euro should perhaps not come as a surprise. This is also true of the euro against the franc: As we described in our last Investment Policy, political risks and indeed economic risks such as the spread of coronavirus can have the effect of boosting the Swiss franc and the greenback through greater demand for “safe havens”. For the Swiss National Bank, the level last reached at the end of February 2017 (around 1.06) represents a key support level. More intervention than we have seen so far will probably be necessary to prevent a renewed surge of the franc against the euro. In percentage terms, the slide from 1.15 to 1.10 was virtually the same as from 1.10 to 1.06. In other words, technical analysts could start to focus on the support level of 1.02 if the SNB fails to build a wall of support for the euro.

It is above all in the commodity markets that China’s share of overall demand is particularly pronounced. In the area of industrial metals Chinese demand typically accounts for more than 50%, and even in the crude oil market it amounts to about 15% – hardly surprising, as China has become the world’s leading manufacturing nation, procuring its energy for production not just from coal but also oil. The Organization of the Petroleum Exporting Countries must (together with Russia) further reduce its crude oil production in order for the oil price to rise by any meaningful amount, particularly as the US has ratcheted up production once again with a view to gaining market share. The existing OPEC production cut of 2.1 million barrels a day, which is set to hold until the end of March, should be raised in order to compensate for the sharp decline in Chinese demand for oil in the wake of the coronavirus crisis. In the event of a credible production cut or a successful containment of coronavirus, the oil price could bounce back. 

Until then, gold will continue to be in demand as a safe haven – although from a technical standpoint this precious metal is significantly overbought.

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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Editorial deadline: 19 February 2020

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