August was a particularly difficult month for the world's equity markets, which suffered a loss of more than 4% after a more stable month in July. The escalation in trade tensions weighed heavily on the markets. However, things are beginning to settle down.
Overall, economic growth is still well-established. It is driven by domestic demand, although at the same time hindered by private investment and exports. The industrial sector bears witness to this, still reflecting the disagreements that continue to affect global trade.
Europe is paying the price for the ongoing political turmoil in the UK, with Boris Johnson taking over the helm as Prime Minister. It is clear that his presence on the political stage makes it more likely than ever that the UK will exit the EU with no deal.
In this troubled environment, the central banks have clearly stated their intention to do whatever is necessary to maintain economic growth.
In this troubled environment, the central banks have clearly stated their intention to do whatever is necessary to maintain economic growth. Like the US Federal Reserve (Fed), a number of central banks in emerging countries have entered a phase of lowering their key rates with a view to sustaining economic activity. Likewise, we expect the European Central Bank (ECB) to follow suit and announce, in the coming weeks, a new programme of asset purchases, after a hiatus of around one year. However, given that financial conditions are already very accommodative in developed countries and that interest rates are close to zero or even in negative territory, the economic effects resulting from even more relaxed monetary policies could be relatively limited.
In terms of flight to safety, the bond markets have performed very well. In Europe, financing rates that are extremely low, and even negative in some cases, continue to attract our attention. For example, note that countries such as Germany, Denmark and the Netherlands have obtained financing at negative interest rates on all maturities since the beginning of August.
It is clear that such a degree of unpredictability on the commercial front is unfavourable to economic activity, the industrial sector and international trade. As the political situation is still very relevant and very volatile, we prefer to take a cautious approach, maintaining our slight underweighting on equity markets in the short term.
After a very positive start to the year, the markets saw a downturn over the summer holiday period. This consolidation was accompanied by fears linked to the emergence of a recession. However, current macroeconomic indicators still show no sign of a widespread recession, although they do suggest an economic slowdown. Despite this slowdown, the equity markets have performed very strongly since the beginning of the year (double-digit gains).
Faced with this uncertain environment, we are maintaining our cautious approach with regard to the equity markets, with the aim of reducing the volatility of the portfolios. Moreover, many of the existing risks (Brexit, political instability in Italy, the trade war between the United States and China, political tensions in the Middle East, etc.) are also motivating us to remain prudent.
In terms of sectoral recommendations, we still favour the communication services and real estate sectors. The communication services sector has the advantage of being exposed to resilient stocks (telecoms operators) and growth stocks (internet giants). The real estate sector benefits from its defensive nature, an environment of low interest rates, and attractive valuations. However, we continue to steer clear of the utilities, commodities and IT sectors, especially the semiconductors segment. Valuations in the utilities sector are high even though there are no growth prospects. Our underexposure in the commodities sector allows us to reduce the cyclical nature of the portfolios by avoiding companies whose revenues are strongly linked to economic conditions and whose cost bases are fixed. Finally, we have a negative opinion about the IT sector because of our view of the semiconductors segment. These stocks are the most volatile in the sector and are likely to suffer as a result of the current economic slowdown.
Reporting season for the second quarter begins in July. As is generally the case, the consensus over expected earnings has been gradually downgraded. However, investors attention is likely to focus on third quarter guidances. The question of a rebound in the second half is a key topic keeping investors in suspense. They are generally under-invested in equities. If guidances for the second half of the year seemed positive, or better than expected, there would likely be a vacuum effect that could drive equity markets to a new high. Some companies, particularly in the semi-conductors sector, are starting to announce that this rebound should happen at the end of the year or even in 2020. Ultimately, equity-market performance over the next six months will depend heavily on the extent of these revisions.
Sovereign yields and bonds
After the inversion of the curve between the 10-year and 2-year yields, which occurred this year in the United States, investors witnessed a similar phenomenon in Germany in August, which only increased concerns that a recession could follow.
There is a reason why more than 25% of bonds worldwide are now offering negative yields and, for the first time in its history, Germany has issued a bond maturing in 30 years that has a negative yield if the investor holds on to the bond until maturity.
On 31 July, the US Federal Reserve (Fed) cut its key rate by 0,25%. The markets are now expecting the European Central Bank (ECB) to ease its monetary policy. It could not only reduce its key rates, but also resume its asset purchase programme.
Given the interest rate cuts expected by the markets, investing in a money market instrument in EUR is not an attractive option for investors.
On the credit market, August began with a significant increase in risk premiums, as the US president announced additional customs duties on Chinese imports. This return of trade tensions weighed heavily on investors’ morale, especially as economic indicators across the world are showing signs of feverishness. In absolute terms, over the month, US credit was still affected by this return of risk aversion while European credit recovered quickly, posting stable risk premiums.
These fears aside, the credit markets in the United States and in Europe are both seeing sustainable demand because sovereign yields are very low. Many investors are subject to restrictions in terms of yields: insurance companies, for example, are turning towards private-sector debt in order to obtain greater returns. In addition, in Europe, the resumption of the ECB's asset purchase programme would make demand for private-sector debt even more sustainable.
Consequently, in our opinion, credit will continue to be an attractive asset class despite fears around the economy, as demand is likely to remain high. However, we believe that we should favour less cyclical, high-quality companies and very liquid investment vehicles.
This summer, the USD regained some ground against the EUR, and the cut in key rates by the US Federal Reserve (Fed) was helpful in this respect. The reduction in yield spreads between the USD and the EUR should have caused the EUR to appreciate, but the macroeconomic indicators in the zone turned out to be less favourable than expected.
In recent weeks, many central banks across the world have reduced their key rates: Australia, South Korea, South Africa, Turkey, Russia, New Zealand, Brazil and Mexico. In this ongoing downward spiral, the financial markets expect the Fed to cut rates twice between now and the end of the year. In the eurozone, a number of accommodative monetary measures are expected from the European Central Bank (ECB).
Consequently, we are still keeping a close eye on the speeches and decisions of the ECB and the Fed, which could affect the exchange rate. Investors are watching out for a more significant cut in rates by the United States than in the eurozone. As a result, the EUR is unlikely to fall below the 1,10 mark. Moreover, it does not seem likely that the EUR will appreciate to more than 1,14 because the economic climate in Europe is more restricted than in the United States.
US President Donald Trump announced that he would impose new sanctions on Iran, as he plans to strengthen pressure on the country's leaders and restrict the Iranian economy even further. These geopolitical tensions therefore led investors to look to gold. Gold soared and exceeded USD 1.400 per ounce.
What is really remarkable is that this good performance has arisen in an environment where equity markets are reaching historic highs and there is no sign of inflation. How has this phenomenon come about? Two main factors come to mind: firstly, investors are manifestly seeking to increase their investments in an asset class that is traditionally qualified as a safe haven, which will provide protection in an environment of volatile markets. Secondly, the very low and even negative interest rates across the world have brought gold back into favour as it brings in positive returns.
Gold is uncorrelated from the world's equity markets and, as such, it can represent an opportunity for diversification and is a good option when building a balanced portfolio. This is significant enough to envisage an increase in demand in the near future. The prices recently seen are sustainable, even with a correction in the short term (the upturn has been very rapid), and we believe that gold prices could remain at current levels and are maintaining a positive view over the medium term. We believe that taking advantage of this situation involves not simply holding physical gold; investing in gold mining companies can offer an additional benefit.
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This document was produced by the Private Banking Unit and BCEE Asset Man-agement. The drafting of this document was completed on 7 May 2019 at 11:10 am.
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