Signs of stabilization

Investment Policy, January 2020

Signs of stabilization

The central banksʼ increased injections of liquidity into the financial markets are bolstering the markets – and equities are no exception. The European Central Bankʼs return to quantitative easing a few weeks ago is supporting the global interest rate cuts implemented to date and should stimulate economic growth in Europe in 2020. Although not yet definitively conclusive, initial signs of stabilization are evident in Europeʼs economic momentum. As in other regions, these signs are coming from the manufacturing industries. It is currently important to note that the services sector data appear to be somewhat mixed. Employment trends remain a key factor for consumption in Europe, the emerging markets and the US. The latest US labour market report is supporting the equity markets. Europe, as a cyclically sensitive region, could profit from a continued stabilization of political and economic momentum: its relative undervaluation is factoring in a risk premium.

The state of the world economy is not entirely clear as 2019 draws to a close. On the positive side, various indications point to a stabilization of worldwide manufacturing activity – the most conspicuously weak area of the global economy in the last few quarters. This is of particular significance for developments in Europe going forward. Rather mixed signals are coming from the global service industry. The US economy is currently presenting an inconsistent picture, distorted by a number of special factors including the impact of the recent strike at General Motors. Overall, however, signs of stabilization predominate globally: this can be seen in the emerging markets – and now gradually also in Europe – in the manufacturing sector, which is especially important to these economies.

A more generous supply of liquidity from the central banks is always a positive factor for equity markets, and indeed this has been stepped up in recent months as interest rates have been lowered around the world. The quantitative easing which the European Central Bank resumed in November (long-term interest rates were rereduced sharply by way of bond purchases) is of particular significance here. While we do not share the ECB’s hope that this will bring inflation close to the 2% target, we see indications that it will enable Europeʼs economy to bottom out and even start improving again. Though not yet conclusive, signs of stabilization from various countries are pointing to this.

The lower base of economic activity witnessed in the fourth quarter of last year and the first quarter of 2019 is producing a statistical effect which increases the prospect of a gradual year-on-year improvement in economic figures, especially in Europe. Moreover, the current undervaluation of European equities relative to the world share index indicates that a risk premium is still in place and that pessimism is being priced in. All in all, and together with the previously observed series of performance figures lagging behind the world share index, this spells upside potential for the pan-European share index – which of course also contains British equities, undervalued since 2016 (the year of the Brexit referendum).

Continuing economic stabilization could give a boost to European equities.

Gérard Piasko, Chief Investment Officer

The majority of bond markets (especially corporate bonds) trended sideways in the past few weeks. Slightly higher inflation expectations driven by a stabilization of global economic growth would affect government bonds more than corporate bonds. In the event of a general decline in investorsʼ risk appetite, high-yield bonds are likely to suffer more than the other sectors. Consequently, we continue to favour corporate bonds with an investment grade credit rating. In the coming weeks, bond markets (government bonds in particular) will react sensitively to information updates on the US-China trade deal as well as to new inflation data. The fact that only a limited number of new bond offerings are expected is generally positive for all bond segments.

At a global level, numerous currency pairs have for some time been showing a decrease in volatility (i.e. volatility actually realized as well as volatility implied in the option markets or anticipated by the market overall). This is also seen in a narrower bandwidth of the euro against the Swiss franc and the US dollar. Given the expected decrease in market volumes during the approaching public holidays, we would not be surprised if currencies were to become more volatile – given that volatility is close to historic lows. This could lead to generally broader trading ranges. In terms of the euro against the US dollar this would mean around 1.09-1.14. However, any further stabilization of European economic data will increase the likelihood of an upward movement, due to the bottomingout that has been in evidence for some time now. This in turn could weaken the years-long period of strength witnessed by the US dollar if next yearʼs growth difference attracts fewer capital inflows into the American currency. The dollar could then lose ground against the Swiss franc within its multi-month sideways channel.

Key commodities have also been showing less movement than before. The WTI Crude has maintained its previous bandwidth of around USD 50-60 per barrel, and volatility has also decreased significantly. The latest oil production decisions taken by the Organization of the Petroleum Exporting Countries (OPEC) are not triggering any important changes. Further developments in US oil production could prove more significant for oil in the coming months. Gold, which has long been supported by falling interest rates, recently underwent a correction. Whether this correction is now over depends on further developments in the trade war between the US and China. Given Chinaʼs big share of overall demand for industrial metals (e.g. copper), the course of the trade talks would have an even stronger impact here. While gold could become more volatile within a bandwidth of approx. USD 1,430- 1,530, more cyclical commodities such as crude oil or industrial metals might profit from positive news on a US-China trade deal. The last few months, however, have shown the course of the trade conflict to be highly unpredictable. Therefore, we remain neutrally weighted in commodities.

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: 20 December 2019

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