Market Outlook | 1st Quarter 2021

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We expect the world economy to grow around 4.5% in 2021.
  • But the second wave of the pandemic and associated lockdown measures will slow down economic growth in the northern hemisphere in coming months.
  • The distribution of numerous vaccines has begun. The pandemic should be over by mid-2021. Until then, we expect discussions of further fiscal rescue packages in most regions.
  • Yields on many government bonds have continued to show little movement. Meanwhile, some $18 trillion worth of bonds are now trading on a negative yield.
  • We expect a significant recovery in corporate earnings in 2021. But share prices already seem to anticipate a lot of positive news.
  • The US dollar is likely to remain under pressure. The Fed will maintain its loose monetary policy.

Our macroeconomic assessment

Business cycle

  • We expect global economic growth of +4.5% in 2021. Other growth forecasts for 2021 are as follows - USA: +4%, EU: +5.0%, Japan: +2.5%, China: 8%, UK: +5.5%, Switzerland +3%.
  • In the US, the process of formal handover to the Biden Administration has begun. Meanwhile, further progress has been made on the vaccine front. The first regular vaccinations, not related to testing, have already taken place.
  • In contrast to Europe and the US, the pandemic in China and Asia has been largely under control for months. As a result, the gap in economic growth rates between emerging market and western industrial countries has widened.
  • The Ifo business climate index indicates the upswing in Germany has stalled. But in recent months purchasing managers’ indices for the US have managed to stay at high levels.

Germany: Ifo Business Climate Index, last 10 years

 

Source: Bloomberg Finance L.P.

Monetary policy

  • In 2020, the monetary floodgates have been opened more quickly and more aggressively than ever before. Practically all central banks have clearly exceeded their policy mandates, implementing easing measures that regulatory considerations made unthinkable just a few years ago. For example, the Fed has acted like a normal commercial bank in providing companies with short term financing.
  • In order to forestall an impending wave of insolvencies, all major central banks have started to buy the bonds of companies with poor credit ratings. Since most major central banks now have interest rates at or below zero, traditional easing through further interest rate cuts is no longer possible (unless cash is abolished). Central banks will therefore have to maintain their unconventional ways of delivering ultra-loose monetary policy in 2021.
  • The European Central Bank (ECB) announced in December that it would increase its balance sheet expansion program by 500 billion euros (or by about 35%). Originally, some within the ECB were even calling for a 750 billion-euro expansion.
  • The ECB has also increased its "Targeted Longer-Term Refinancing Operations" program. Commercial banks can now borrow up to 55% of their outstanding loans from the ECB under special conditions.

Our investment policy conclusions

Bonds

  • Yields on government bonds in the most important markets are under control from the central banks' point of view. The market’s pricing mechanism has been eliminated and thus there is no risk that reckless borrowers will get “punished” via rising yields. Worldwide, bonds with a total nominal value around 18 trillion US dollars are now trading on negative yields.
  • The dimensions of the various central bank purchase programs, and of state refinancing needs that result from massive fiscal stimulus, make this essential.
  • This trend is leading to "creeping death" for the bond markets: central banks under the clear leadership of Japan now hold between 35% and 90% of outstanding government bonds. And the first tendencies towards market domination by the state can also be seen in the area of corporate bonds.

10 year government bond yields last 5 years, in %

Source: Bloomberg Finance L.P.

Equities

  • Positive developments regarding Corona vaccines have triggered a very buoyant mood in stock markets over the last few weeks. Widespread optimism is expressed in sentiment indicators, some of which are close to extreme readings. For example, bull-bear indicators, call-put ratios and the CNN Fear & Greed index are back at February levels.
  • A whole series of IPOs (e.g., AirBnB, Doordash, etc.) from companies that are far from generating profits have found their way to the market in its present euphoric state. In some cases, these new stock offerings have initially traded at over 100% above the issue price. This phenomenon brings back memories of the winter of 1999/2000 - shortly before the bursting of the "tech bubble".
  • We view short-term setbacks in the stock markets as an opportunity for additional purchases. In the medium term, the attractiveness of equities as real assets remains a significant support.

Equity markets, perfomance year to date, indexed

Source: Bloomberg Finance L.P.

Forex

  • The US dollar has come under increasing pressure in recent days and is trading at multi-year lows. Expectations not only of a US aid package in the near term but also of subsequent packages to support the economy are the reason for this. In this respect, the US dollar - much like the US bond market - is not giving the same optimistic message as the US stock market.
  • This starting position is again putting pressure on the other central banks to try to weaken their appreciating currencies. Paradoxically, last week's ECB meeting and the gigantic measures announced (the increase in QE, the expansion of TLTRO) were interpreted by the foreign exchange market as indicating ECB weakness, in the sense that "the ECB is at the end of its tether".
  • The Chinese central bank is, behind the scenes, effectively and calmly counteracting the appreciation of the yuan through

EUR/USD, last 2 years

Source: Bloomberg Finance L.P.


Disclaimer. Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no undertaking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information provided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other transaction. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.

Market Outlook | 4th Quarter 2020

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We expect the world economy to contract some 4.5% in 2020 but forecast the recovery will produce 3.5% growth in 2021.
  • Right now, the global economic recovery is losing some momentum because Covid-19 infections are rising again. The economic effects of the Covid-19 pandemic have forced practically all central banks to push their policy interest rates close to zero. These central banks are now following the path already taken by the ECB and the Bank of Japan.
  • Yields on government bonds continue their consolidation phase. The Fed is buying around $120bn worth of government and other bonds per month.
  • Through its purchases of corporate bonds the Fed is pushing down yields in the secondary market.
  • Equity markets have started to correct with technology shares leading the declines. Markets are closing in on technical support levels.

Our macroeconomic assessment

Business cycle

  • Our growth forecasts for 2020 (and 2021 in brackets) are as follows – World economy: -4.5% (+3.5%), US: -6.5% (+4%), EU: -7% (+5.5%), Japan: -5% (+2.5%), UK: -8% (+6%), Switzerland: -5% (+3%).
  • The economic recovery is continuing at a slower pace due to an impending second wave of the Covid-19 virus and statistical “base effects”.
  • The US economy urgently needs another rescue package. Since July 31, nearly 30 million unemployed Americans have no longer been receiving their additional weekly benefit of $600 a head. Democrats and Republicans are fighting over the necessary size of a further package as well as aiming for votes in the US elections on November 3rd. Given the political strife in Washington it is becoming ever more likely that a new rescue package will only be agreed after the upcoming Presidential election.

Purchasing Manager Index for Russia

Source: Bloomberg Finance L.P.

Monetary policy

  • The Fed has clearly communicated to the market the conditions that must be met for an initial rate hike: full or overemployment, inflation of at least 2% and the prospect of a moderate overshoot of the inflation target for some time.
  • Interestingly, the markets were largely left in the dark about the other main tool in the Fed's armory, the securities purchase and balance sheet expansion programs. However, it was communicated that securities purchases are going to be continued, at the current or a higher rate, for some time to come.
  • The expansion of central bank balance sheets has led to a sharp rise in the supply of money and a collapse of spreads on riskier bonds. This has “forced” investors to increase portfolio risk, including through investment in stocks. Low credit spreads and high stock prices have helped companies to access much-needed capital and liquidity during the lockdowns.
  • The purchase programs of the Fed and the ECB mean that real interest rates out to 10 years are zero or even negative for corporates, even though companies and governments have been issuing new debt at a record pace. Thus, fundamentally poor credits are being kept on life-support at the expense of economic efficiency.

Our investment policy conclusions

Bonds

  • Central banks are still buying government bonds but demand for them is also coming from institutional investors again looking for “safe havens” as stock markets suffer another bout of profit-taking.
  • But real yields in all currencies are now clearly in the negative range, making the entire asset class fundamentally unattractive.
  • The supply side is set to increase massively in coming months as the various fiscal support packages need to be financed. Moreover, the most important central banks have recently signaled that they are not currently planning an immediate expansion of their security purchase programs.

10 year government bond yields last 5 years, in %

Source: Bloomberg Finance L.P.

Equities

  •  After a massive rally in August and the first half of September, which was mainly driven by a few large technology groups and characterized by some unhealthy developments, disillusion has now set in. In recent weeks, various indicators had already pointed to the risk of a correction. The trigger was probably the rather cautious communication of the Fed regarding "support" for the economy from the monetary side.
  • Fed Chairman Powell's demand that politicians must now take further fiscal measures collided with the fact that Republicans and Democrats have been unable to agree on the scope of the CARES 2.0 package.
  • We are assuming markets will now have to go through a difficult phase. The longer the impasse, the less certainty as to whether and how there will be a result in the US Presidential election.

Equity markets, perfomance year to date, indexed

Source: Bloomberg Finance L.P.

Forex

  • Outstanding futures contracts betting on a falling US dollar reached record levels in September. So, with hindsight it is not surprising that a countermovement has now occurred, with the dollar rising in recent trading. One trigger for this could have been the communication from the ECB, which tried to weaken the euro after it rose above 1.20 on the EUR/USD. On the other hand, dollar purchases could be linked to the correction in stock markets. Both tendencies can be considered as part of a move to "risk-off". Stocks are clearly risk assets and the dollar is often perceived as a haven when investor uncertainty rises.
  • All central banks face a dilemma when their currencies appreciate. Currency appreciation is not welcomed in an economic world that can only generate growth via competitive devaluation.
  • The EUR/CHF currency pair is now just below 1.08. Europe is currently not in focus as a source of headlines, so demand for the Swiss franc is only moderate.

EUR/USD, last two years

Source: Bloomberg Finance L.P.


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 3rd Quarter 2020

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We expect global economic growth of -5% (+3.5%) for 2020 (2021). USA: -8% (+4%), EU: -9% (5.5%), Japan: -6% (2.5%), UK: -10% (+6%).
  • While re-openings (or the reversal of previous lock-down measures) may lead in the short term to higher growth, we don‘t expect a V-shaped recovery.
  • We are going to see an increase in insolvencies despite all the government rescue packages and central bank balance sheet expansion.
  • The Fed may well introduce measures to control the entire yield curve (yield curve control). Agents have sufficient resources to resume their activities.
  • Stock market developments are not consistent with trends in macro-economic data.
  • Widespread expectations of a V-shaped recovery have resulted in high valuations for certain asset classes.
  • Forex markets have been rather stable of late.
  • We continue to have a positive outlook for gold.

Our macroeconomic assessment

Business cycle

  • SECO is forecasting a decline of -6.7% in 2020 after adjusting for sports events. And the Bundesrat has agreed an aid package of CHF 40 billion, equivalent to around 6% of Swiss GDP. Switzerland's budget is manageable thanks to the restrictions on Federal debt levels (the debt brake) introduced in 2003. So there is no threat of a debt crisis. Switzerland has one of the best country credit ratings worldwide.
  • May data on the US job market delivered one of the biggest positive surprises in years. While the consensus expectation was for the US unemployment rate to rise from 14.7% to 19%, a fall to 13.3% was reported. And whereas a fall in non-farm payrolls of 7.5 million had been expected, the report indicated a monthly increase of 2.5 million jobs. The financial markets celebrated the May labor market report with a firework display of stock price gains.

Switzerland Purchasing Manager Index and GDP, 10 years

Switzerland Purchasing Manager Index and GDP, 10 years
Source: Bloomberg Finance L.P.

Monetary policy

  • Many market participants assume that the Fed will fight an equity bear market more aggressively than it ever has in the past. This expectation, as well as the extremely aggressive expansion of the Fed’s balance sheet and the creation of excess liquidity, explain why stocks have been able to post such strong gains at a time when the US economy is likely facing the worst recession since the Great Depression.
  • US short-term interest rates have never been as low as they now are - neither during the Great Depression nor during the Second World War, when the Fed simply dictated short-term interest rates.
  • Recently, and the first time in months, the Fed's balance sheet has declined very slightly, reflecting a fall in US dollar swap activity between the Fed and other central banks. This is a positive sign that the US dollar funding squeeze may be coming to an end.
  • The European Central Bank has decided to extend its Pandemic Emergency Purchase Program (PEPP) and to expand it by EUR 600 billion. The ECB thus promises to buy up a total of 1’350 billion euros in bonds and to run the program until at least mid-2021.

Our investment policy conclusions

Bonds

  • Right now, US bond markets are focused primarily on how a dramatically increasing supply of bonds resulting from US fiscal stimulus can be absorbed. The Fed is fundamentally a buyer of bonds (due to QE), but to a lesser extent than previously. The risk that oversupply causes interest rates to rise must be avoided at all costs. The easiest way would be through yield curve control (YCC), whereby the Fed would set interest rates across the yield curve. In such a world there is no need for the market to set bond prices.
  • This strategy was implemented in the US in the 1940s. The aim then was to "inflate away" for a time astronomical war-related debts via negative real interest rates.

10 year government bond yields last 5 years, in %

10 year government bond yields 5 years, in %
Source: Bloomberg Finance L.P.

Equities

  • Since the lows of mid-March, world stock markets have recovered by around 35%. This development appears in conflict with the economic outlook as many macro indicators are now signaling that there will be no V-shaped recovery.
  • An interesting criterion for the valuation of stocks is the so-called Buffett indicator which places the entire stock market capitalization in relation to GDP. In the US, this ratio is back up to levels last seen in the "tech bubble" of 1999/2000. By almost any measure market valuations look elevated. Warren Buffett regularly comments on this and has emphasized that he can't see any cheaply valued companies to buy.

Equity markets, perfomance year to date, indexed

Equity markets, performance year to date, indexed
Source: Bloomberg Finance L.P.

Forex

  • The Swiss franc remains in demand given the increasing uncertainty in Europe. The SNB has once more become significantly more active in its forex intervention, as the latest statistics show.
  • The US dollar has moved only slightly against the other major currencies of late. Previous “financing stress” in the euro-dollar area has subsided in the context of the Fed provision of USD swap lines to a large number of central banks. The price for this access to USD liquidity is a greater dependence on the USD area. There are those who see these developments as a preparation for the introduction of the US dollar as the “world currency”.

USD/CHF, last two years

USD/CHF, last two years
Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 2nd Quarter 2020

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We now forecast the world economy will contract by 1% in 2020.
  • With the coronavirus now affecting all parts of the world and widespread quarantine restrictions we have substantially cut our estimates for economic activity this year.
  • It is already clear that the first half of 2020 will see a collapse in growth rates. As a result, it looks as though this will cause negative growth in many regions for 2020 as a whole.
  • On a worldwide basis, governments are introducing protective packages to try and stave off widespread bankruptcies. When (hopefully within two to three months) economies start to pick up again, it is essential that companies and other economic agents have sufficient resources to resume their activities.
  • We are slightly underweight in equities. While patience looks appropriate right now, we intend to take advantage of future setbacks to build up positions.

Our macroeconomic assessment

Business cycle

  • We now forecast that the world economy will contract by 1% in 2020. Covid-19 has led to a partial shutdown of economic activity in large parts of the world. It is both a supply and a demand shock. A sharp recession is now unavoidable in most countries. Critical for the economic outlook will be how quickly the number of new infections can be reduced, thus allowing quarantine restrictions to be lifted.
  • The Eurozone Purchasing Managers’ index (PMI) collapsed in March to 31.4, its lowest level since 1998. Meanwhile, the UK PMI also reported a massive decline to 37.1. These falls are more dramatic that those at time of the global financial crisis. The March reading for the US PMI was 40.5 (compared to the consensus estimate of 44 and February’s 49.6). We expect a further sharp fall in the April US report.

Eurozone Purchasing Managers’ index, last three years

Eurozone Purchasing Managers’ index, last three years
Source: Bloomberg Finance L.P.

Monetary policy

  • The coronavirus is probably the biggest supply shock the industrialized world has ever experienced. An ever-larger proportion of the global workforce is subject to isolation or quarantine and cannot work. Central banks can’t prevent this from happening.
  • But central banks can prevent a massive credit crunch such as might lead to a global wave of bankruptcies. Valuable time can thus be saved until fiscal rescue packages, which the politicians put together, can be implemented and take effect. Central banks can react immediately; fiscal bailouts take time.
  • Thus we believe that central banks still have a vital role to play, even though, with interest rates at zero and given the previous expansion of their balance sheets, they have already used up many of the weapons in their armory. As lenders of last resort they can prevent a system crash, financing if need be the massive fiscal packages now being put together. “Yes they can”.
  • The ECB will buy up 750 billion euros worth of bonds by the end of the year and will offer banks extremely favorable financing terms. The Fed has bought nearly $600 billion in US bonds, equivalent to nearly 3% of US GDP.

Our investment policy conclusions

Bonds

  • Government bond markets have gyrated wildly in recent days. The equity crash has impacted correlations between the various asset classes including government bonds. At times, these were sold heavily as leveraged and other investors sought to raise cash where they could.
  • Following announcements of massive security purchase programs by the central banks market conditions have stabilized somewhat. The Fed‘s balance sheet already stands at $4.6 trillion and further substantial increases are in prospect.
  • On the other hand, government economic rescue packages will need to be financed through the bond markets. We expect a huge increase in the supply of government bonds.

10 year government bond yields last 5 years, in %

10 year government bond yields years, in %
Source: Bloomberg Finance L.P.

Equities

  • The crash in stock markets has been exacerbated by the forced reduction of leveraged positions due to margin calls. Analysts estimate that up to $12,000 billion in margin calls might have been triggered, resulting in the sale of assets across all asset classes. In addition, the market has obviously needed to react to a dramatically worsening macro situation. Right now, the uncertainty is huge as no one can predict how the shutdown will impact large parts of the global economy and what might be the knock-on effects on corporate balance sheets and profits.
  • We will slowly start to lift our underweight in the equity quota, with a focus on US and Swiss companies. Among sectors, we favor technology, pharma and healthcare as well as consumer staples. We will avoid sectors and companies where cash flows stand to be substantially impacted by the coronavirus crisis.

Equity markets, perfomance year to date, indexed

Equity markets, perfomance year to date, indexed
Source: Bloomberg Finance L.P.

Forex

  • Given the huge upheavals in all asset markets, it is unsurprising that the major currencies become more volatile. As the crash developed the dollar came initially under pressure. Subsequently it has been heavily in demand as investors sought dollar liquidity to service margin calls. Swap lines with all major currencies have now been made available by the Fed, alleviating the problem somewhat. The US dollar is generally “king” during a crisis and has been so yet again this time.
  • But we view the present situation as highly unstable as astronomically rising public debts could well force trading patterns into an entirely different direction. How long will markets continue to trust “fiat” currencies given the massive funding requirements of governments and the extent to which these stand to be financed through monetary creation? A loss of confidence in the global currency system could have catastrophic consequences. In this context, we note that credit default swaps for the US have risen recently from 15 to 25 basis points.

EUR/USD, last two years

EUR/USD, last two years
Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 1st Quarter 2020

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We forecast the world economy will grow 2.9% this year and by slightly less - 2.8% - in 2020.
  • Our regional and country growth forecasts for 2020 and (in brackets) 2019 are as follows: US: 2.2% (2.3%), Euroland: 1.2%, (1.3%), Switzerland: 1.7% (0.9%), China: 5.8% (5.9%), Japan: 1.0% (1.2%), UK: 1.0% (0.8%).
  • Over the course of next year, we expect that world economic growth will gradually stabilize.
  • The ECB and the Fed will continue their processes of balance sheet expansion. In case of weak growth we would expect the Fed to react with further rate cuts.
  • We remain slightly underweight in equities. Various technical indicators suggest that markets are “overbought” on a short-term perspective.
  • Gold tends to do well when perceptions of geo-political risk rise and when real interest rates fall. We remain committed to our gold position.

Our macroeconomic assessment

Business cycle

  • We expect that the world economy will stabilize in 2020, not least on account of widespread monetary stimulus, but also the growing prospect for fiscal stimulus in Europe and in certain developing countries. Moreover, it seems the already announced Phase 1 agreement in trade negotiations between China and the US will be signed and partially implemented in January. This should support international trade and, therefore, the broader growth process.
  • Phase 1 of a US-China trade agreement, designed to put the bilateral trading relation on a friendlier footing, has been negotiated and is ready for signature in January. The US will not introduce fresh tariffs and will remove some existing ones while China has committed itself to purchase $50bn worth of US agricultural products. While we expect this Phase 1 deal will get implemented, this is not yet a total certainty.

US real GDP, % growth, quarter on quarter

US real GDP, % growth, quarter on quarter
Source: Reuters, Datastream

Monetary policy

  • FOMC member rate projections indicate no rise in rates in 2020 but one rise in both 2021 and 2022.
  • The statement issued following December's FOMC meeting removed the word “uncertainty” and indicated that (currently very limited) inflationary pressure is being closely monitored.
  • The Fed still views the long-term neutral interest rate as 2.5%. We are not as optimistic as the FOMC and see further rate cuts as a possibility.
  • Given ongoing balance sheet expansion, at least in the early part of next year, the Fed policy stance can still be viewed as very expansionary.
  • ECB President Mme. Lagarde has now had seven weeks in her new job but has not yet produced any surprise in her statements on monetary policy.
  • There are tentative signs that the European economy is stabilizing and that investors view the still-high downside risks (geo-politics, protectionism) as having lessened somewhat. For now we share this view and as a result think further rate cuts from the ECB are unlikely in 2020. But we expect the ECB’s bond purchase program to continue at its current rate of 20bn. euros a month.

Our investment policy conclusions

Bonds

  • The now steeper yield curves are an expression that some optimism has returned regarding the outlook for the world economy. In particular, more investors seem to have come round to the view that this year’s slowdown in US growth was probably only temporary and that a reacceleration is in prospect. This view is supported by the recently announced agreement on a Phase 1 deal in US-China trade negotiations.
  • But continued evidence of extreme liquidity shortfalls in America’s shadow banking system is concerning. This shows up in the strong commercial bank demand for borrowed funds from the Fed. Thus, by the end of the year the Fed will have had to provide an additional $500bn to America’s financial system, more than offsetting efforts to reduce the size of its balance sheet.

10 year government bond yields last 5 years, in %

10 year government bond yields years, in %
Source: Bloomberg Finance L.P.

Equities

  • All along, the equity markets have been fairly convinced that some sort of trade deal would be put together. So the announcement on a Phase 1 deal in US-China trade negotiations was broadly discounted by the markets. Even so, it is amazing how markets seem to dance to the tune set by the media, including the many digital, social platforms. It’s legitimate to consider who are the beneficiaries of this trend.
  • We do not expect to change our strategic assessment of equities in the coming year, as the absence of attractive alternative asset classes looks set to continue. However, we are tactically cautious because valuations are high and sentiment and other technical metrics indicate elevated risk in stock markets. Markets are always vulnerable to setbacks and now, just after the announcement of a trade agreement between China and the US, could be a classic “sell the good news” opportunity.

Equity markets, perfomance year to date, indexed

Equity markets, perfomance year to date, indexed
Source: Bloomberg Finance L.P.

 

Forex

  • Forex markets have been quiet of late, but the British pound is an exception. Following the decisive Tory victory in mid-December it has strengthened significantly. We note, however, that even here profit-taking has set in.
  • The Chinese yuan has strengthened following the announcement of a Phase 1 trade deal between the US and China. One can assume that this deal has the approval of the Chinese government. For the time being, markets seem content to interpret the deal as clearing the way to a “blue sky” environment with no unsettling problems on the horizon.
  • We continue to expect the dollar to move sideways, even though on a trade-weighted basis it is currently trading at almost a new high. The verbal interventions of the Trump Administration aimed at devaluing the dollar have declined significantly of late.

EUR/USD, last two years

GBP/USD, last two years
Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 4th Quarter 2019

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We expect the world economy to grow by 2.9% in 2019.
  • Our key regional and country growth forecasts are as follows: US: 2.1%, Euroland: 0.8%, Switzerland: 0.9%, China: 5.8%, Japan: 1.0%, UK: 0.9%.
  • The economic cycle continues to lose momentum with service sectors now starting to show signs of weakness.
  • As had been expected, the Fed and the ECB shifted their monetary policies in the direction of stimulus in September.
  • The Fed‘s FOMC is split on whether to cut interest rates further and stresses the role of data dependence in policy-setting. At most, we expect one further rate cut out of the Fed this year.
  • Bonds with a face value of some $15 trillion are posting negative yields.
  • We remain slightly underweight in equities and expect stock markets to remain volatile.
  • Gold tends to rise as real interest rates fall. We remain committed to our gold investments.

Our macroeconomic assessment

Business cycle

  • The OECD has joined the ranks of those reducing their growth forecasts. OECD forecasts now put world economic growth at 2.9% for 2019, as against 3.2% at the start of the year. For the coming year, world GDP is expected to grow 3%.
  • The European economy has been particularly disappointing. The Eurozone Purchasing Managers’ index for manufacturing fell in September from 47 to 45.6, compared to a predicted rise to 47.3. Meanwhile Germany’s Purchasing Managers’ index for the manufacturing sector, reported at 43.5 in August, fell to the shockingly low level of 41.4 in September when a slight rise to 44 had been predicted. It seems Europe’s services sector is now also on a weakening trend.
  • The index for US consumer confidence reported a sharp fall in September, from 135.1 to 125.1. America’s trade conflicts (especially with China) as well as the more uncertain political situation have depressed confidence.

New York FED recession model: likelihood of recession

Rezessionsmodell der New York FED
Source: New York Fed

Monetary policy

  • In September, the ECB reduced its key policy rate from -0.4% to -0.5%. Also the ECB‘s bond-buying program will be restarted. As from November, the ECB will be buying bonds at the rate of Euro 20bn. a month.
  • At the same time “forward guidance” has become more aggressive. And it is hoped that, with better access to long-term credit, Europe‘s banking system will become more robust.
  • Today’s very low interest rate policies are resulting in a very unequal distribution of wealth. With very high prices for equities, bonds and property, those who already own these assets, often financed by credit, are doing very well. Meanwhile savers and the poor are disadvantaged.
  • Thus, in September the ECB delivered what the markets had been expecting. According to Reuters, economists surveyed prior to the ECB‘s September policy meeting had been expecting an interest rate cut of 10 basis points, renewed bond-buying of the order of Euro 30bn. a month, easier credit facilities for Europe‘s banks and the promise that European interest rates would be kept very low “for longer“.
  • As expected, the Fed cut its key policy rate for a second time by 25 basis points at its September meeting. However, the Fed also stated that the hurdles for further interest rate reductions are “high” given the very strong US labor market and that a severe economic downturn is not currently in Fed forecasts.

Our investment policy conclusions

Bonds

  • After the sharp decline in bond yields towards the end of the summer, there has been some consolidation in yields at slightly higher levels. It looks as though recession fears – which in August led to such panic-buying of “safety” investments that the yield on the 10-year Treasury fell to 1.5%, with the yield curve partially inverting – have dissipated to some extent.
  • With a large portion of Europe’s bond markets now trading on negative yields, there is the obvious question as to who will now buy these bonds given the certainty of loss if they are held to maturity. Are Europe’s bond investors succumbing to hopes that the future will provide “even dumber” investors to whom positions can be sold on at even higher prices? We have a highly unstable situation in Europe’s bond markets.

10 year government bond yields last 5 years, in %

10 year government bond yields last 4 years, in %
Source: Bloomberg Finance L.P.

Equities

  • This year’s motto for equity investors seems to be: “ignore the macro data and trust in the central banks”. Thus some major markets have recently been able to drift back up towards all-time highs.
  • On an index unit basis, analyst expectations for 2019 earnings for S&P 500 companies are now around $165. If the US economy does not succumb to recession, it is likely that US corporate earnings will accelerate somewhat next year. From a valuation perspective, today’s interest rates might imply a P/E ratio for the S&P 500 between 17 and 19. In turn, this suggests a level for the index between 2800 and 3100.
  • Overall, we remain underweight in equities as an asset class. But we will be inclined to view any substantial setback in the markets as a buying opportunity, with a focus on quality companies.

Equity markets, perfomance year to date, indexed

Equity markets, perfomance year to date, indexed
Source: Bloomberg Finance L.P.

 

Forex

  • The ECB must take care that, with its decision to become more expansionary in September, the euro does not become too weak against the US dollar. Should this happen Washington might seek revenge, perhaps through the introduction of higher tariffs on European cars imports. From this perspective, the $1.10 mark against the euro seems to be a good support level.
  • In general terms we think that the US dollar will continue to move sideways against the other major currencies, even though on a purchasing power basis the US unit is trading at a new high. This has infuriated the US President who has been putting strong pressure on the Fed to reduce interest rates sharply. Latterly, Washington’ rhetoric has moderated somewhat – perhaps in assent to the motto that “the best country deserves the strongest currency“.
  • Euro weakness – a reflection in part of the ECB’s recent measures and developments in the UK – has unsurprisingly boosted demand for the Swiss franc. Despite this, forex trading suggests the Swiss central bank has read recent market trends well.

EUR/USD, last two years

EUR/USD, last two years
Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook| 3d Quarter 2019

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We expect the world economy to grow by 3.0% in 2019.
  • Our key regional and country growth forecasts are as follows: US: 2.2%, Euroland: 1.0%, Switzerland: 1.1%, China: 5.9%, Japan: 1.0%, UK: 1.0%.
  • The US trade conflict with China has intensified, a peaceful resolution is not in sight.
  • The ECB and the Fed have announced that they will switch to a more expansionary policy stance if inflation targets are not met.
  • The face value of outstanding government debt posting negative yields stands at $12.5 trillion.
  • Corporate bonds have become expensive and therefore less atractive.
  • We are staying slightly underweight in equities for the time being.
  • Gold has breached important technical levels to the upside. Looking forward, it should be in demand given the now lower interest rate expectations of investors and rising geo-political tensions.

Our macroeconomic assessment

Business cycle

  • The global economy has continued to lose momentum. While service sectors have managed keep afloat and construction has grown in most countries, manufacturing has continued to suffer. We expect 3% growth for the world economy in 2019.
  • The Eurozone‘s manufacturing sector continues to weaken. This and the intensification of trade hostilities between the US and China cause particular problems for Germany (on account of the high export share in its GDP) and for Italy (whose industrial sector accounts for a large portion of the economy in value added terms). The latest business cycle indicators, for example the ZEW index for Germany show no improvement.
  • The May reading for China’s business confidence index was a disappointing 49.4.

Fed and ECB policy interest rates since 1999

Source: Bloomberg Finance L.P.

Monetary policy

  • The Fed‘s Open Market Committee (FOMC) met over June 18 and 19 but produced little in the way of surprise. Already, in early June, Fed sources had suggested that US interest rates were likely to fall. Markets are now pricing in an interest rate cut following the July FOMC meeting with a further one or two cuts before the end of the year. As it did in January, the Fed has reacted to a marked fall in expected inflation rates. It seems that the Fed will do all it can to avoid what has happened in Japan and in parts of Europe – namely falling inflation rates triggering falling inflation expectations.
  • We forecast two 25 basis point US interest rate cuts before the year end. Should this happen, the US dollar could well come under pressure as the ECB would probably not fully match the Fed’s rate cuts. The dollar is in any event somewhat overvalued, and a declining US interest rate differential would support a correction.
  • ECB Chairman Mario Draghi surprised markets on 18 June with his announcement that stimulus would be increased were the ECB´s inflation target to be missed in the future. This suggests an increased likelihood of a rate cut and a resumption of balance sheet expansion in the coming quarters.

Our investment policy conclusions

Bonds

  • The decline in bond yields since the start of the year has continued and has even accelerated following recent remarks from the Fed and the ECB. Markets seem in the grip of a general tendency to even lower yields. “Core” European bond markets are now even more substantially in negative yield territory, something that has made bond investment extremely difficult.
  • Worldwide, the face value of outstanding government bonds that are currently posting negative yields is around $12.5 trillion. This greatly favors governments at the expense of investors. (Often grossly) indebted states can refinance and service their debts on extremely favorable terms while investors, above all in the benchmark institutional sector, are deprived of income as a result of the negative yields they are obliged to accept for top quality bonds.

10 year government bond yields last 4 years, in %

Source: Bloomberg Finance L.P.

Equities

  • The major equity markets, with year to date performances between 15% and 20%, are now strongly in positive territory. But there are exceptions – notably Japan and emerging markets, which have taken a hit as the US-China trade conflict has intensified. The speed of some recent falls among emerging markets does catch the eye. But we note that Germany’s DAX index has been able to stay among the best performers despite Germany’s export orientation. And the performance of the Swiss SMI, which has been boosted by the strong showing of some defensive heavyweights, is very encouraging
  • We think markets will continue to be impacted by trade hostilities. And President Trump’s Twitter feed is not helping in this respect. Probably a sustained further rise in equities needs better trends in macro data as well as more confidence in the earnings power of companies.

Equity markets, perfomance year to date, indexed

Source: Bloomberg Finance L.P.

 

Forex

  • On the whole we continue to think that the US dollar will move sideways, even though it has come under pressure following the Fed’s FOMC meeting on June 18 and 19. The surprisingly "dovish" tone of recent Fed communication has left its mark on forex markets. Especially against the yen a marked weakening of the US currency has occurred. The weaker dollar is very welcome in Mr. Trump’s White House.
  • The Chinese yuan has appreciated of late. This can be seen as a reward from China to Washington for reacting positively to suggestions of a resumption in trade negotiations.
  • The EUR/CHF has come under modest pressure recently, partly in the context of greater Brexit uncertainty and the sense that a “hard Brexit” has become more likely. But developments in Italy (the possible introduction of Treasury mini bills, or mini bots, which some think could create a parallel currency to the euro, as well as the threatened resignation of Deputy Prime Minister Salvini) mean an increase in investor uncertainty, which almost always favors the Swiss franc.

USD/JPY, last two years

Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 2nd Quarter 2019

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • We expect the world economy to grow by 3.0% in 2019.
  • Our key regional and country growth forecasts are as follows: US: 2.2%, Euroland: 1.0%, Switzerland: 1.3%, China: 5.9%, Japan: 1.0%, UK: 1.3%.
  • The slowdown in growth reflects principally trends in the manufacturing sector. Service sectors are in general holding up.
  • The ECB is not expected to raise its rates before next year.
  • The US yield curve is signaling a weakening of the economy.
  • If economic trends do not improve soon, equity markets will become increasingly vulnerable to a sell-off.
  • But strongly oversold conditions could provide attractive tactical opportunities for equity purchases.
  • Gold is now performing better due to changing expectations on the future path of US interest rates and the US dollar.

Our macroeconomic assessment

Business cycle

  • The US cannot escape a cooling global economy. And we forecast lower US growth for this year – at around 2.2%. The Fed and the Trump Administration are doing all they can to extend what is already a very long period of expansion. Now nearly 10 years old, the present upswing is already close to beating the previous record of 120 months (from March 1991 to March 2001, trough to peak) as reported in NBER data.
  • Parts of the Eurozone, especially the industrial sector and parts of Europe’s periphery are already in recession. But service sectors are doing better. We now forecast the Eurozone growth rate at 1% for 2019.
  • The IFO Business Climate indicator, one of the most important leading indicator for the German economy, rose in March to 99.6 compared with 98.7 in the previous month. This points to some stabilization after several months of slowdown.

Fed and ECB policy interest rates since 1999

Source: Bloomberg Finance L.P.

Monetary policy

  • Given the noticeable slowdown the Fed has shifted its monetary policy away from “normalization” and back to being “data dependent”. Probably the performance of financial markets was the key factor in this shift. The Fed does not want the US stock market to fall substantially. The message for investors is that Fed policy is indeed “data dependent” but the dependence is rather on the behavior of the financial markets. In our view, the Fed has decided to adopt an additional policy objective – namely to keep the equity markets from tumbling.
  • Specifically, the Fed has communicated that its balance sheet reduction will be slowed from May and terminated from September. Meanwhile Fed guidance indicates no further interest rate rise this year.
  • The Eurozone economy is so weak that the ECB has revived its long-term emergency credit scheme (TLTRO) to provide cheap finance to Europe’s banks. The ECB has said that the slowdown in the Eurozone has been steeper and more widespread than it expected. The change of view is reflected in the cut in the ECB’s 2019 growth forecast – from 1.7% to 1.1% – and the announcement that Eurozone rates will not rise until 2020 at the earliest.

Our investment policy conclusions

Bonds

  • Weakening trends in global macro data have led to a renewed flattening, and even a partial inversion, of the US yield curve. This development has been supported by very cautious statements coming out of the Fed, especially with regard to the global economy. The Fed’s emphasis on the risks to growth, and the fact that inflation continues not to accelerate, have encouraged investors to buy US Treasuries.
  • There is also a clear trend in European bond markets. In both core and peripheral markets, yields have declined significantly. Here too, the central bank has played a key part in influencing markets. The ECB has clearly pointed out the trend to weaker growth and has insisted that its policy tool kit contains further instruments to support Europe’s economy.

10 year government bond yields last 4 years, in %

Source: Bloomberg Finance L.P.

Equities

  • Currently we have a neutral allocation to equities but have started to take some profits. For us, the explosive gains of the latest stock market rally raise a question as to its sustainability. Given that trends in macro data and also in corporate earnings are now weaker, we have concerns as to the direction markets have taken in recent weeks.
  • Fund flows tell us something as to whether markets are firmly-based or vulnerable. Hedge funds and CTAs were prompt to shift positions from “short” to “long” in early January. But retail investors, steady sellers over the first 10 weeks of this year, have latterly moved to become net-buyers. We note the common belief that retail investors are poor market-timers.

Equity markets, perfomance year to date, indexed

Source: Bloomberg Finance L.P.

 

Forex

  • Communications from the Fed and the ECB seem to have had little impact on forex markets of late. But recent disappointing figures for Europe’s Purchasing Managers’ indices did put the euro under pressure. We believe the EUR/USD will continue to move within the 1.12 to 1.16 channel for the time being.
  • It is a similar range-bound story for the USD/CHF. Both currencies are widely regarded as safe havens and they have hardly moved against one another in recent months. We expect this trend to continue. On the one hand, US deficits suggest that the US dollar should be weaker. On the other, the interest rate differential in favor of the US is still substantial. That fact, and the relatively low level of “investor uncertainty” will probably prevent a substantial investor push into the Swiss franc.
  • The British pound stabilized as a postponement of the original Brexit deadline became a serious prospect. Right now, there are many potential pathways as to how the Brexit affair will develop. While we accept the pound could weaken further in the near term, its fundamental cheapness points to a longer-term attraction.

EUR/USD, last two years

Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 1st Quarter 2019

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • The global economy has lost momentum. We expect world economic growth will be between 3% and 3.5% in 2019.
  • The major components of our 2019 world economic growth forecast are as follows – US: 2.3%, Euroland: 1.8%, China: 6.2% and Japan: 1.0%.
  • We expect two further interest rate rises from the Fed in 2019.
  • The first ECB rate hike will not happen before autumn 2019
  • Following the December Fed policy meeting yields on 10 year Treasury bonds have fallen back - to around 2.75%.
  • World stock markets fell substantially in 2019, undermined by a deteriorating outlook for growth and increasing political uncertainty. We advocate a defensive investment strategy for 2019.
  • But deeply “oversold” markets conditions could well provide tactical buying opportunities in the year to come.

Our macroeconomic assessment

Business cycle

  • We forecast world economic growth at between 3% and 3.5% in 2019. Slower growth next year reflects in part a forecast reduction in US growth, which we estimate at 2.3% for 2019. The impact of the Trump fiscal stimulus is fading, while there are first signs the more restrictive Fed policy is working to cool the economy.
  • The recent G20 summit produced a sort of truce in America’s trade war with China. The US undertook not to introduce new tariffs or to raise existing ones for 90 days. The bargain could bring some short term improvement to business confidence and to financial markets. But we fear that trade hostilities will break out again once those 90 days have elapsed.
  • We forecast Eurozone growth at 1.8% in 2019. Within the Eurozone, “Target 2” imbalances continue to widen. There are signs of capital flight from Italy.

FOMC Mitglieder «Dots»

Source: Bloomberg Finance L.P.

Monetary policy

  • At its December FOMC meeting the Fed, as expected, raised its target range for the key Fed funds interest rate. From the “dot forecasts” of FOMC members (shown in the graph), it appears that a majority now expect only two further interest rate rises in 2019 and that the current phase of rising US interest rates will have run its course by 2020.
  • In general, we believe that central banks will have some success in normalizing monetary policies next year, despite clear signs of a less strong economy. That said, the extraordinarily stimulative policies they have felt obliged to pursue over the last several years mean that they are now poorly placed to provide further stimulus in the event of a future recession.
  • The Fed is not slackening the pace of its balance sheet contraction ($50bn. per month), arguing the present course is justified by the still relatively strong economy, labor market conditions and the generally moderate trend in price pressures. Future Fed actions will be driven chiefly by the business cycle.
  • The ECB will terminate its bond purchase program at the end of 2018. But the first ECB interest rate hike should not be expected before the autumn of 2019. Maturing issues in the ECB’s massive bond portfolio will presumably be reinvested in longer-dated securities.

Our investment policy conclusions

Bonds

  • Following the latest FOMC meeting, the yield on 10 year US Treasuries has fallen to around 2.75%. This sharp move probably reflects the deteriorating stock market environment which in turn has prompted investors to move to “risk off”. The “risk off” trade has also been encouraged by recent Fed comments on the inflation outlook.
  • The very flat US yield curve which has emerged from recent trading could well be suggesting the following: (i) inflation is not going to “surprise” on the upside, (ii) the Fed will remain fairly cautious when it comes to further rate rises and (iii) this will lead to a “soft landing” for the US economy. That said, we also think the yield curve now implies an increased chance of a serious disruption to growth.

10 year government bond yields last 4 years, in %

Source: Bloomberg Finance L.P.

Equities

  • For equity investors the fourth quarter of 2018 has led to a sobering reassessment. Now that the US market has followed the others in posting a negative return for the year as a whole, many are wondering “Why?”. We think a variety of political uncertainties and the deteriorating outlook for growth are chiefly to blame. They have unsettled investors and cost them performance. A further factor is the tighter liquidity environment consequent on the Fed’s balance sheet reduction program. Now that the Fed is no longer seen as friendly, markets seem to be looking for new leadership, something that for many will require portfolio adjustments.
  • Rising interest rates and increased growth uncertainties have led to profit-taking in industrial and IT stocks in particular. We think there is an ongoing rotation out of growth areas such as Tech and in favor of “defensives” – such as insurance, utility and consumer staples stocks.

Equity markets, perfomance year to date, indexed

Source: Bloomberg Finance L.P.

 

Forex

  • The US dollar has moved sideways against most other currencies recently, most obviously against the Chinese yuan. The decisions of the December FOMC meeting were broadly expected by the markets, so did not have much impact on forex rates. Hedging US dollar positions is not appropriate at the moment given the large US dollar interest rate differential and low volatilities in dollar exchange rates.
  • But the British pound is showing substantial volatility. The pound rose following the agreement on post-Brexit arrangements between Mrs. May and the EU. But, as it became clear that Mrs. May’s deal as outlined would not pass in the UK parliament, the pound lost value again and the “cable” (GBP/USD) falling to 1.25.
  • The EUR/CHF has been relatively stable at around 1.13. The Swiss franc rose briefly at the start of December in the context of rumors that the Swiss National Bank was set to end its policy of negative interest rates, but has since fallen back.

EUR/USD, last two years

Source: Bloomberg Finance L.P.

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.

Market Outlook | 4th Quarter 2018

Tactical Perspective:

Macro Bonds Equities Other Asset Classes

Executive Summary

  • World economic growth will exceed 3.5% this year.
  • But we expect growth will slow in 2019.
  • The world’s exporting countries are being hit by the President Trump’s protectionist measures.
  • The Trump Administration’s pro-cyclical US fiscal policy will have a disastrous effect on US government finances over the medium term. But in the near term it is generating very strong economic and profits growth.
  • We expect 3-4 further rate hikes from the Fed until end of 2019.
  • The ECB’s first cyclical rate hike is not expected before the summer of 2019.
  • Yields on US government bonds have risen again.
  • Despite the flatter yield curve we don’t expect a recession.
  • 2018 equity performance tables are now led by the US. Emerging markets are at the bottom of the pack.
  • We are maintaining our underweight position in equities, waiting for better opportunities to build up equity positions.
  • The US dollar has again fallen back slightly. Gold remains under pressure.

Our macroeconomic assessment

Business cycle

  • We have the following economic growth forecasts for 2018 and, in brackets, for 2019. World: 3.5% (3.3%), US: 2.7% (2.3%), Euroland: 2.1% (1.9%), China: 6.5% (6.2%) and Japan: 1.1% (1.0%). The Chinese economy is being hurt by President Trump’s import tariffs.
  • We forecast some falling off in growth rates next year. The Fed is set to pursue a more restrictive monetary policy and the boost to the US economy from last year’s tax cuts will start to wear off. The US trade war against China will also tend to put a brake on America’s currently very high economic growth rate.
  • China’s Caixin PMI has shown a weakening tendency for some months now. It seems that Chinese government efforts to slow down the strong growth of credit are having some effect.

Caixin Purchasing Managers Index for China since 2015

Source: Bloomberg

Monetary policy

  • The US unemployment rate has now sunk below 3.9%. Clearly, the US economy has moved beyond “full employment” and is now growing “above capacity”. We expect US wage inflation to rise significantly in coming quarters. The American economy is “hot” and we expect the Fed to react with 3-4 further rate hikes until end of 2019. Attempts by President Trump browbeat the Fed towards more policy accommodation will not have much impact.
  • The first cyclical rise in Euroland rates will not happen before the summer of 2019. The ECB’s bond purchase program will terminate at the end of this year. However, maturing bonds will still be reinvested into longer-dated issues thereafter.
  • The SNB will only be in a position to raise Swiss interest rates once the ECB has made its interest rate move.
  • We expect that the Bank of England will not raise UK rates before next year, and then only in circumstances of an orderly Brexit process.
  • In general, the central banks should manage to move in the direction of monetary policy normalization in 2019. And the generous liquidity provision of 2018 will gradually fade from investor consciousness.

Our investment policy conclusions

Bonds

  • Yields on 10 year US Treasuries now stand at 3.1%, and have therefore risen above the important psychological hurdle of 3%. The latest upward move reflects strong US labor market data, and especially signs of a pick up in wage inflation.
  • The still very flat US yield curve seems to us to be suggesting the following: (i) inflation is not going to “surprise” on the upside, (ii) the Fed will be fairly cautious when it comes to further rate rises (“data dependence”) and (iii) this will lead to a “soft landing” for the US economy.
  • Yields on 10 year German Bunds have also risen and now stand at 0.5%. The rising trend in yields applies as well to Swiss Government bonds, although here the pivot at which yields turn positive is still around 10 years out.

10 year government bond yields since 2014, %

Source: Bloomberg

Equities

  • The US stock market is leading this year’s equity market performance table, despite recent profit-taking in technology shares. Soon, the US third quarter corporate earnings season will begin. Investors have set the bar for these third quarter results quite high, expecting a similar strong growth in earnings to that reported for the second quarter.
  • Many European stock markets are showing a slightly negative performance year to date, a reflection of Europe’s export dependence at a time of increased trade hostilities and her structural economic problems.
  • Emerging market indices are generally showing a significantly negative performance on a year to date basis. While many of these developing economies have strong growth prospects over the long term, their stock markets are being adversely affected by the currently strong US dollar and by rising US interest rates. Overall, the indebtedness of many emerging market economies is now at a record high.

Equitiy markets, perfomance year do date

Quelle: Bloomberg

 

Forex

  • In recent weeks the US dollar has lost some ground against most currencies. There has been some comment that the ECB’s first rate rise might be brought forward. Also, and despite the hostilities directed at them by the Trump Administration, Chinese officials have been “cooperative” in acting to fix the yuan at a slightly higher rate.
  • The Swiss franc is a good barometer as to investor concerns regarding Europe’s structural problems. Right now, the franc is in strong demand and the Swiss National Bank (SNB) has had to purchase substantial amounts of foreign currency in order to brake the franc’s upward move. The SNB is in a bind: It’s economic stability mandate suggests higher rates are needed to cool the hot Swiss property market. On the other hand, the currency impact of higher rates could trigger a destruction of Switzerland’s export competitiveness. So the SNB has to leave rates where they are. An aggravation of Europe’s problems, for example concerning Italy or Brexit, could trigger further euro weakness, boosting investor demand for the Swiss franc still higher.

EUR/USD, last two years

Source: Bloomberg

 


Disclaimer. Produced by Investment Center Aquila Ltd. The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completenessof these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered.