In October, equity markets rose a little over 2% after rising 1,9% in September. Following the peak in September, global equity markets hit new historical highs, remaining caught in a tug-of-war between the global economic slowdown and the extremely accommodative central banks which are allowing these markets to remain positive.
From an economic perspective, it is clear that household consumption continues to drive growth, particularly thanks to the low unemployment rate in developed economies. However, this strong dependence on consumers is a source of feverishness for the global economy, which is why the latest signs of weakness in consumer confidence levels and the slowdown in retail sales are early-warning indicators that we are following very closely.
By contrast, the markets’ optimism stems mainly from the proactive intervention of central banks that prefer taking preventive rather than corrective action.
Generally, they have begun a cycle of rate cuts in order to finance and promote production in the real economy. Mario Draghi, the outgoing President of the European Central Bank (ECB), known for doing “whatever it takes” to save the euro in the past, again introduced a very ambitious asset purchase programme to help finance companies. On 1 November, Christine Lagarde took the helm at the ECB in a very challenging environment.
In the United States, the Federal Reserve (or Fed) is still in a phase of rate cuts and seems ready to make concessions on the inflation target in the event that it remains for a certain period above the target of 2% per year. In order to avoid the turmoil seen in September on the money markets, the Fed also intervened heavily in order to provide the liquidity needed by financial institutions. This is particularly apparent in the expansion of the Fed's balance sheet—a first since the end of unconventional monetary policies (i.e. quantitative easing) in the United States.
It is common knowledge that the economic outlook is bearing the cost of a political environment that is lacking stability. This scenario, which we have described in prior publications, is weighing on the confidence of manufacturers and consumers. This context therefore causes us to remain cautious by maintaining our short-term underweight position on the equity markets to take advantage of falling prices in order to reposition ourselves.
At the end of the period from 30 September to 29 October, the performances of the main global equity indices calculated in euros were all positive: 0,62% for the MSCI World Index (a global equity market index), 1,45% for the MSCI Europe Index, 0,30% for the MSCI North America Index and 2,45% for the MSCI Emerging Markets Index.
While global growth is causing financial markets to worry, this does not mean they are no longer robust. In fact, the main indices have risen sharply since the beginning of the year (27% for North America and 21% for Europe), and the main equity indices are approaching historical highs.
The markets are rising unevenly, keeping stride with the progress made in the trade war between the US and China. Based on the latest news, part of the agreement could be signed in November. In addition, it appears that the situation in the United Kingdom is no longer as great a concern for investors, despite Parliament's rejection of the Brexit deal. The deadline of 31 October was postponed again, with British MPs refusing to approve the timetable for the laws required to enact the agreement negotiated by Boris Johnson. Finally, Q3 results were down 3,8% on average compared to the same period in 2018, with markets not correcting because earnings season was less negative than investors expected. For approximately 80% of companies listed on the S&P 500 that have already published, the results exceeded expected earnings per share.
Our view of the equity markets remains negative. Reducing portfolio volatility is a priority since the economic slowdown is spreading and many risks remain—Brexit and the trade tensions have not yet reached any solution, political tensions are increasing in the Middle East and the financial situation of certain emerging countries is alarming. It should be noted that the structural difficulties Europe is facing have caused European stocks to struggle. Their US counterparts have the advantage of being growth-oriented, leading us to favour US equities over European equities.
In terms of sector recommendations, our allocation allows us to reduce the cyclicality of portfolios to a minimum: we are favouring communications services and real estate and maintain our negative view of materials, energy and semiconductors, the most cyclical part of the IT sector.
Sovereign yields and bonds
After plummeting to historically low levels, European sovereign rates finally started to pick up again. This was undoubtedly due in part to the likely agreement between the EU and the UK and the progress between the US and China.
The yield on the German 10-year Bund rose to -0,35%, comparable to July levels. Peripheral countries also saw their yields rise, albeit less dramatically. Despite these increased yields, inflation struggled to pick up in Europe, as evidenced by a core inflation rate which has been stuck at an average of only 1% since the asset purchase programme was launched in 2015. Moreover, inflation expectations remain at a historically low level. In addition, the ECB will continue to maintain rates at low levels through its accommodative measures as long as inflation does not sustainably reach its target of nearly 2%. In view of the ECB’s inflation forecast for end-2019 (and 2020), rates are not set to pick up in the near future.
In the US, sovereign rates reacted strongly to expectations of an imminent resolution of the trade conflict with China, driving yields up. Since US rates remain largely positive, the Fed still has some room for manoeuvre to cut them in order to support the economy. Given the downward trend and historically low rates in Europe, investing in a money market instrument denominated in euros is not an attractive option for investors.
On the credit market, October was dominated by two main themes—Brexit and the trade war. In Europe, private debt risk premiums have not shown a clear trend since the European Central Bank (ECB) announced the return of its asset purchase programme in September. Last month, Brexit uncertainties ahead of the departure date hampered demand for European credit before the proposed agreement re-stimulated it. On the US credit market, progress in negotiations with China made private debt more attractive, justifying the tightening of risk premiums.
Against this background, the slogan on both continents is “wait and see” for two reasons. In the short term, the first reason is that it is the earnings season. The second is that in Europe, investors remain unclear about Brexit, which has been postponed yet again, and about the portion of the ECB’s purchase programme that could be allocated to private-sector debt. In the US, it is mainly the trade war that is fuelling investors' expectations.
In this context, which favours the status quo, we believe that credit remains an attractive asset class. This is particularly because very low sovereign rates create demand for private debt. Nevertheless, our economic concerns have caused us to opt for non-cyclical, high-quality and highly liquid companies.
The euro rose against the dollar as negotiations progressed and as financial markets saw increased transparency on the terms of Brexit. Once the hope of a quick and clear exit evaporated, the euro began to fall once again.
In terms of the monetary policies of the ECB and the Fed, it is clear that the Fed has more room for manoeuvre to cut rates in order to stimulate the US economy if need be. At the end of its October meeting, the Fed cut its key rates by another 25 basis points. As for Europe, we believe that the ECB will not carry out any further monetary easing in 2019.
We continue to pay close attention to macroeconomic publications that could affect the exchange rate. As such, the euro should not fall below the threshold of 1,05, but it is unlikely to rise above 1,15, since the economic climate in Europe is less favourable than in the US.
Some more speculative investors have started to take profits on their positions, while underlying demand from central banks and private investors (largely from China, Russia and India) remains strong. Moreover, November is wedding season in India, which is causing demand for gold products to rise at a time when the population celebrates Diwali, the festival of lights.
The structural reasons for investing in precious metals remain relevant: central banks are diversifying their reserves, the middle class is growing in emerging countries and currency prices are volatile, making gold attractive due to the stability of its equivalent value in dollars. In addition, geopolitical tensions (in Chile, Iran, Venezuela, Argentina, Hong Kong, Lebanon and Turkey) tend to benefit precious metals because they are safe havens, which stand to gain from volatility on the stock markets. Because it is in demand, the relative value of gold is rising. We believe that gold prices could remain in the USD 1.500 - 1.560 range per ounce, with even better prices in the medium term.
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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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