Investors are nervous. After markets climbed inexorably for months, the sentiment changed in September: The broad-based S&P 500 Index has temporarily lost up to 10% since the beginning of the month, while the Nasdaq 100 Index lost up to 14%. The Asian markets are also trading very nervously. Investors are becoming increasingly aware that the virus is far from being defeated. The word “lock-down” is making the rounds again. The recent measures in the UK, Spain and France do not bode well. Not even the FED’s announcement that it will keep interest rates ultra-low for at least three more years has managed to reassure the markets this time. Investors are once again focusing on fundamental data and have realized that stocks are expensive. Are they all expensive? Really?
The corona crisis is largely over. At least that is what the leading stock market indices say: The S&P 500, DAX and SMI have largely recovered their March losses or, in the case of the Nasdaq, are even trading at new highs. However, a closer analysis of this rise reveals that especially the tech stocks, which have long since made more than a V-shaped recovery, have shot up to new record levels. Many other stocks have not been able to recover as quickly and are showing a rather L-shaped trend. In fact, the Corona crisis has opened a large gap between the performance of cheap value stocks and glamorous growth stocks. The gap between winners and losers and the enormous flood of liquidity by central banks, only seen before in times of war, led analysts to speak of a K-shaped market trend and wonder how long this situation can last.
We will soon have a vaccine. The question of its long-term effectiveness is still completely open, but at first, we can expect a certain normalisation of our social and business life, our leisure time, and our travel behaviour. This will increase the possibility of inflation, which will undoubtedly benefit undervalued cyclical or value stocks more than growth stocks. In that way this valuation gap, this “K”, will be closed. It could therefore be a unique moment to buy cheap value stocks.
Only if the current situation (no vaccinations, economic stagnation, and low inflation) continues for a longer period, will it make sense to carry on paying record high prices for glamorous tech titles, as investors, if nothing changes, tend to invest in those stocks that have done well in the past instead of looking ahead.
The relative outperformance of growth stocks versus value stocks has been going on since 2007 and has accelerated further during the Corona crisis. However, investors do not believe in a “comeback” of value stocks any more than they do in a year-end rally, a China crash or Santa Claus. Many have already been disappointed on several occasions and do not want to hear it again, so they keep on buying the expensive growth stocks and selling the value ones. Meanwhile the difference in the valuation of these stocks is immense: Value stocks are cheaper than ever, with a price/earnings ratio of half the market average. In contrast, the valuation of growth stocks is four times higher than the average. Still, for the comeback of these stocks, a trigger is needed, such as higher interest rates.
Nobody really believes that interest rates will rise again, and central banks are avoiding this at all costs. But what happens if inflation gets out of control? The danger is real, because for the first time in decades, monetary and fiscal policy are simultaneously very expansionary. The budget deficits in many countries this year will reach a level in relation to gross domestic product that was last recorded during the Second World War. How this “expansionary era” in terms of inflation will end is currently completely open.
Nevertheless, we are gradually preparing our portfolios for a possible rise in inflation expectations, which we hope would help value stocks to outperform strongly.
SOURCE: TEXT OF PETER FRECH, FONDMANAGER QUANTEX
After the sell-off in March, equity and credit markets recovered significantly in April and May. In April, the global equity market index MSCI experienced its strongest monthly rise in 33 years, rising 10.4%. Positive news regarding the development of COVID 19 pandemic and the increasing normalisation of public life in many countries after the lockdown period led to a price increase in many risk assets classes.
June began with renewed price rises, especially in the USA. The FED meeting on June 10th put an abrupt end on this optimism. FED Chairman J. Powell explained that he does not expect the economy to recover quickly. The FED is expected to keep interest rates at current levels until the end of 2022, maintain the current volume of bond purchases and, as he announced a week later, buy additional bonds from companies that are having difficulty obtaining credit. With this new measure, the FED wants to avoid a possible liquidity crisis.
The European Central Bank (ECB) could soon follow the example of the FED and extend its rescue program to bonds of companies that have lost their investment grade rating. Such companies are known as “fallen angels” and their credit rating has been downgraded to “BB+” or lower. This has already happened to 15 companies in Europe this year, including Lufthansa, British Airways, Rolls-Royce and Renault. In the USA there are already 25 cases this year, including Ford, Kraft Heinz and Macy’s. All known names.
While analysts are still arguing whether the economic recovery can be described by letters such as V, U, W or L, this discussion has already been clearly answered by the Central Banks with their liquidity injections: It is a clear U. After a phase of balance sheet reduction in 2017 and 2018, the global central banks, led by the FED, have resumed the “old” policy of quantitative easing. One could easily speak of the largest “money print operation” in the history of Central Banks.
This enormous expansion of liquidity will lead to higher equity valuations and mitigate the negative impact of the pandemic crisis on corporate earnings. The current monetary policy is an important support for the global stock markets, and despite the risk of this policy (e.g. zombie economy), investors have almost no choice but to stay invested and follow the trend. The most important thing is that the companies one invests in are profitable and have sufficient liquidity.
The volatility in the markets will continue, as a lot of good news regarding the outcome of the health crisis are already priced in and any bad news, such as a possible second wave of infection, can quickly lead to market corrections. In addition, we must keep an eye on the relationship between the USA and China.
The last few weeks we have reduced some risk positions in our portfolios, and we have sufficient liquidity to reinvest. We believe that the money will soon flow back into European and Asian equities. We remain defensively positioned thanks to our overweight in sectors such as healthcare. However, we also have positions in some more cyclical market sectors, such as technology, and increasingly in investment-grade corporate bonds that can benefit from the Federal Reserve’s purchasing program.
On 19 February the stock markets were still very positive. The markets initially ignored the threat of the Covid 19 virus, even making up for the losses of late January and reaching new all-time highs. Market participants concentrated again, at least for a short time, on the recovery of profits and the economy, until the coronavirus once again caught the attention of investors in the last week of February. The spread of the virus in Western Europe triggered panic selling across all asset classes at the end of the month. Now, a month later, nothing is the same.
The speed of the fall in equity prices can only be compared to the crashes of 1929 and 1987. In 1929, the world economic crisis swept the globe, and on Black Monday, October 19, 1987, the US leading barometer Dow Jones Industrial fell by 22.6%. Although the 2008 financial crisis ended in higher losses, these were not as abrupt as the current ones.
The corona pandemic disrupted both the supply and demand sides of the global economy. This has been followed by a liquidity crisis in the financial markets and, to make matters worse, there is a war on oil prices between Saudi Arabia and Russia.
The simultaneous decline in supply and demand accompanied by the collapse of oil prices has never been seen before. That is why the governments are having great difficulty in finding measures that adequately respond to this new challenge, especially since they cannot use any known measures. A state stimulus of the “social consumption”, bringing people closer together, is neither possible nor desirable currently. If people go back to restaurants, shops and cinemas in large numbers and consume more, the health crisis will worsen.
The pessimism in the markets does not surprise us: healthcare systems are under stress. Anyone belonging to a risk group has every reason to be concerned. Companies and people are fighting for their existence. Great uncertainty and insecurity prevail. Stock market prices are collapsing.
In the coming weeks, perhaps months, the world will not get any better. We will continue to feel the economic consequences of this standstill for a long time to come. But as in every crisis, this fall will find its lowest point before it starts to pick up again. On the stock markets, as always, the turnaround will come suddenly and as a surprise.
That is why we will not touch anything in our portfolios for the time being and do not plan to make any new investment decisions until the situation has calmed down.
A year ago, conventional wisdom became convinced that a stock market correction was really the beginning of a “bear market,” and a sure sign that recession was on its way. Conventional wisdom was wrong again.
The pouting pundits still talk about low economic growth and fret that a trade war is brewing. Meanwhile the S&P 500 has risen by 28.9 % by mid-December, the MSCI EUROPE by 23 % and the DAX by 25.8 %.
Many market experts are still surprised by the last rise in risk assets: Given the weakening of the global economy, the new equity highs and the decline in credit spreads, do not match reality.
So, what is the reason for the recent rise in stock markets? Are the pessimists right? Is there any sign of recovery in the manufacturing industry?
In order to answer these questions, we often analyse leading indicators, such as the Purchase Manager Index (PMI), which provides information about current sentiment in the industry. In the case of the PMI, values above 50 indicate an economic expansion, values below 50 indicate an economic contraction. In October, the world’s three largest economies – the US, China and the Eurozone – still had values below the 50-point growth mark. However, there were already signs of stabilization at a low level. In November the data was even slightly better in these three countries – USA 48.1 – China 50.2 – euro zone 46.9 -. Nevertheless, this stabilization does not yet answer our questions.
Another positive point is undoubtedly that the service sector has so far not been affected by the weakness of the manufacturing industry. Should this happen, the probability of a recession would increase significantly.
A look at corporate earnings does not really help here, since the analysts’ consensus estimates for corporate earnings have been successively revised downwards this year.
What do we still have left? The most important thing: The change in central bank policy throughout the year, which in our view was the decisive factor. Liquidity on the capital markets has increased significantly as a result of many interest rate cuts and the resumption of the ECB’s bond purchase programme.
Central banks have already shown in the past that they are doing everything in their power to ensure good (re)financing conditions for companies, banks and states, as well as to support the economy. Nothing has changed in this respect today. It is precisely this environment that has had a particularly positive effect on risky assets, such as equities and credit spreads, and explains the positive developments in recent months, although this rise has not been supported by economic data. We regard the fact that the leading indicators for the manufacturing industry worldwide show a stabilisation at a low level as a first positive signal. However, much more important in our view is that central banks have made a significant turnaround this year. This shows that they are willing to do everything they can to get the economy back on track and will therefore continue to provide markets with enough liquidity.
As long as this continues and companies continue to make profits, we are convinced that risk assets will develop positively in the medium term. We do not believe that we will experience a recession in 2020 and maintain our current position in equities and bonds.
SOURCE: FRANK BORCHERS, ETHENEA
The unresolved trade dispute between the US and China has caused markets some more insecurity in the last three months. In mid-August, the President of the United States gave signs of wanting to re-establish negotiations with China, after which the markets managed to recover some of the significant losses recorded at the beginning of the month. However, this commercial war continues to affect the markets till now. Other major concerns are the fear that central banks’ monetary policy will lose its effect, as well as the possible price bubble in the fixed income market.
Concern about a further slowdown in the world economy has also increased in recent months. This economic pessimism can largely be attributed to the aforementioned trade war initiated about a year and a half ago by the President of the United States, which has already had a serious impact on world trade. The fall in world export activity has hit hard on open and export-oriented economies such as Germany, Japan, South Korea and other emerging markets. It is not surprising, therefore, that the German economy, recently regarded as the engine of Europe, has recently shown signs of recession and is in a much worse situation than the French or Spanish economies. The industrial sector, which has a strong presence in these countries and is closely linked to world trade, has come under strong pressure in recent months and is barely growing. The difficult situation of the industrial sector is raising fears of a global recession, as can be seen in most yield curves or in the decline in industrial sentiment indicators. However, a recession in the coming months is not (yet) the most likely scenario.
Due to the good labour market situation, the crisis in the industry is not yet perceptible to global consumers. As a result, the mood of consumers is much better than that of industrials.
If the trade dispute continues to intensify, the recession scenario will become increasingly likely. This would reduce the chances of Donald Trump being re-elected. We will have to see how far the President (or his successors) is willing to go in this dispute.
These uncertainties lead to a risk aversion that is reflected in the diversification and selection of securities in our portfolios. We prefer assets that promise greater resilience in a recession, such as the utilities and basic consumer sectors. On the other hand, cyclical sectors such as industry are undervalued. We also continue to maintain a relatively high cash position, although in the last three months we have gradually reduced this proportion in our portfolios in favour of precious metals.
True to the old stock market saying, “sell in May and go away”, the month of May turned out to be very difficult for the global stock markets. At the beginning of May, a tweet from the US President once again caused problems. Contrary to the general expectation of an early settlement in the trade dispute between the US and China, President Trump threatened to raise again tariffs on certain Chinese imports. China promptly responded with its own tariff increases for US exports to China. As a result, the S & P 500 Index fell 4.5% and Chinese stocks more than 7% at the beginning of May.
Not USA nor China are interested in significantly lower stock prices. Therefore, the USA has already announced that they are interested in meeting with Xi at the G20 summit at the end of June. This could pave the way for an agreement. For their part, Chinese leaders have been also concerned in finding a way to negotiate the details of an agreement with Washington.
Huawei, the Chinese telecommunications giants, was also at the center of disputes between these two countries in May. US suppliers are now required to apply for exemptions in order to continue to supply Huawei. This reminds us of the Iranian oil exports. In this case too, certain customers (China, India, Korea and others) could apply for exemptions in order to continue importing Iranian oil without fearing US sanctions. These special regulations expired at the beginning of May and have not been extended. This has led to an increase in tensions between the US and Iran. In June there were several attacks on oil tankers in the Strait of Hormuz. The Iranian Revolutionary Guard has also shot down an American drone. Immediately thereafter Trump threatened to attack Iran but stopped the attack at the last moment, signalling at the same time his intention to engage in dialogue.
As far as Brexit is concerned in this second quarter, apart from Mrs. May’s resignation, we have not seen much changes. The drama continues. The bankruptcy of the restaurant chains of Jamie Oliver and the collapse of British Steel did not help either to improve their mood. The island seems to be only in football still dominant and that may help them to forget the current problems for a while.
Although global tensions and problems are serious, equity and bond markets have not reacted until now. This is due to continued growth in the service sector of the world’s major economies, steadily rising wages and the expectation that central banks (FED and ECB) will continue to provide support, in the case of the FED by lowering interest rates soon.
We do not believe that higher tariffs will finally affect world trade too much. However, companies need security and political stability to work. If this is not the case, companies will refrain from major investments.
Once again, May has proved to be a difficult month for the stock markets, but this does not mean that we have to sell all our shares. The support from the central banks is far too big for that. And maybe we will soon receive another Tweet with conciliatory words. In addition, there is also the possibility that President Trump and Xi end up reaching an agreement during the G20 summit in late June. *
Hope is the last thing you lose…
The markets started very positive in the New Year. However these last weeks they had some more problems. Still, investors do not have too many reasons to complain. Both equity and fixed income are showing good results.
Is the global economy really gaining momentum – as some big banks say -, after the PMI has been falling gradually during the past 12 months? What about the geopolitical problems (China, Brexit, Italy, commercial war)?
We have to face reality and, at the moment, it does not look too good. We do not like the current combination of falling economic data an persistentyl high debt ratios.
The global manufacturing index – PMI – fell to its lowest level since 2016 in February. At 50.6, this leading indicator is only just above the growth level. In Germany, this figure dropped below 50. On the other hand however, there was an improvement in the services sector and the consumer confidence also increased. The domestic economy in Europe has performed much better than the exports. We might say that domestic consumption was the growth engine of the European economy in February. However, a recovery of the growth data seams unlikely at this time. The data in March were not much better than in February. The end of the cycle seems to be getting closer and closer.
At the end of an economic cycle, the margins are always under pressure. The typical dream in this market phase is a «soft landing», a «soft landing» of the economy after years of boom and misallocation of capital. Of course, the US Federal Reserve’s decision not to raise interest rates is fueling these hopes. But investors want something impossible : if the boom continues, even more rate hikes will be needed and the over-indebted players will collapse. If the economy starts shrinking, corporate profits and household incomes will collapse, and the high debt will not be repaid, even if interest rates fall again.
As for the geopolitical problems, investors also dream here of a quick agreement between the US and China and of a happy ending for an over-indebted Italy and for the BREXIT.
And, the more investors dream, the more cautious we are.
We do not believe that we will see a strong recession, but prefer to maintain a defensive position in the portfolios, with a focus on quality companies with solid balance sheets. The shares of these companies can still be bought at very attractive prices compared to cyclical stocks, precisely because investors believe in the continuation of the economic boom. We have used these months to reduce the most risky positions and, after many years, we return to a neutral position in stocks. We maintain our positions in Emerging Markets and Asia, where we believe there is potential, especially if China reaches a good agreement with the US.
Regarding fixed income, we prefer liquidity to bonds, where we see more potential also in the obligations of emerging countries.
Continuing geopolitical problems, the weakening of the world economy, as well as interest rate hikes in the US, have hit equity investors hard in these three final months of the year. In December, the general uncertainty has created additional selling pressure, anticipating a possible global recession in the next 6 to 12 months. The trade dispute, the uncertainties about the Chinese economy, tighter monetary policy, high international debt, Brexit, insecurities in Europe, as well as the statements of the US President have strongly affected the sentiment of market participants.
“Perception is Reality” is the name of an old Stock market wisdom. We can understand that a discount was priced in for these uncertainties. The predictability of important factors such as the future interest rate policy or free trade has been reduced. In addition, decreasing growth rates in various sectors, e.g. Semiconductors, led to additional volatility.
However, this reduction in valuation is too high given the still high global growth of more than 3%.
According to the Institutional Brokers’ Estimate System (IBES), the P/E ratio of the world equity indices is now 13x for the next 12 months, which is lower than in 2011 (one year after the outbreak of the euro crisis). This rating has been undercut in the last 20 years only in the 2008 financial crisis. Especially value stocks look very attractive today.
If the fears of a recession do not materialize, we will see a significant recovery in the coming weeks, and the current prices are buying opportunities. Of course, we can not predict the economic development exactly; however, the data we have for the next two quarters is still quite encouraging.
The likelihood of a major economic crisis in the next four quarters is low. This should be followed by the stock allocation, right now after the sharp correction. We believe that value stocks provide the biggest upside, and quality stocks will stand periods of higher volatility. *
Driven by continued upbeat economic sentiment and still abundant liquidity, US equities have reached another all-time high. It looks like the major American stock indexes ignore all the political problems and scandals of its president and follow their own path, unlike the rest of the markets that seem not to have a clear trend.
Some analysts are closely following the US yield curve (yields of the US government bonds in relation to their maturity), which this summer had significantly flattened. They worry that the yield curve may flatten, or worse, that it becomes “inverse”, that means, that the long-term interest rates fall below the short-term interest rates, since on many occasions in the past, this inversion has been followed by a recession. We do not believe that this is the case this time and if it were, it would still take a couple of years to reach the dreaded recession.
In September, the Market Composite Purchasing Manager Index for the euro area fell slightly. It indicates solid growth but an easing growth dynamic in the months ahead. The decline was largely due to the manufacturing sector, which suffered from deteriorating sentiment in the auto sector, while the services sector held up. This development may be related to rising fears of an intensifying trade conflict
The UK and its EU partners failed to achieve a breakthrough in the Brexit negotiations at their recent summit. In fact, EU leaders rejected British Prime Minister Theresa May’s latest proposal: a significant disagreement has persisted on the best way to avoid a hard border on the island of Ireland. Given that the UK will leave the EU on 29 March 2019 and since agreements need ratification by both the UK and EU parliaments, time is running short. Compromises on both sides are needed at the important 18-19 October EU summit to reduce the risk of an eventual Brexit without a deal.
The Bank of Japan (BoJ) kept its ultra-loose monetary policy unchanged last week. BoJ Governor, Haruhiko Kuroda rejected speculation that it will normalise monetary policy soon, leaving it as the only major central bank that has not at least planned to do so.
At this moment, what worries us most is a possible inflation in the US, due to the increase in oil prices, a possible trade war (mainly between the US and China, where the problems may last a long time) and finally the political problems in Italy.
That is why, this month we reduced our exposure to equities.
Ongoing solid macro data, good annual and quarterly results and generally a good outlook for companies supported the european stock markets in the first few months of 2018. However, political uncertainties in Italy, political power struggles in Germany, refugee crisis in the EU, threatening trade wars around the globe, based on the US punitive tariffs, and worries about rising interest rates and inflation in the US, soon increased market volatility. These uncertainties were reflected in share prices in June. While leading indicators in the US continued to suggest an upturn in economic momentum, European sentiment indicators were unable to escape the turmoil in the financial markets during the second quarter of 2018.
We believe that global financial markets are currently dominated by political developments, not by macro data. Given the persisting trade dispute, we decided to slightly reduce our risk exposure by selling equities. The proceeds will be placed in cash and reinvested if and when opportunities arise.
The new Year began very well, thanks to solid macro data and the expectation of good corporate results. These circumstances allowed the markets to reach new highs in January, although by the end of the month the stock markets began to fall, reaching their lowest point at the beginning of February. The turbulences in the stock markets also continued during the month of March.
The constant geopolitical risks, the problem of high long-term debt that many countries have, and the recent discussions and threats of new trade barriers between different countries, are making many investors nervous, since these measures could limit the growth potential of the companies.
We started the year with skepticism and we have not changed our opinion during these months. We are still optimistic, but at the same time, prudent.
The world economy registered a solid growth in 2017, gaining momentum during the last semester. The main indicators of the most important economies suggest that this growth may continue for several months, since at the moment, industrial production and world trade continue to grow at a good pace. At the national level, private consumption, supported by high consumer confidence, thanks to solid job creation, is driving this GDP growth.
On the other hand, core inflation has remained throughout 2017 within the margins set by the Central Banks and inflationary pressure has been low. This is starting to change in some countries. That is why we can say, that the risk of deflation has been overcome worldwide and that we even begin to see a certain inflationary pressure.
As possible risks for 2018, we can point out that the USA seems to have entered a late phase of the economic cycle, although not in the final phase. On the other hand, it is expected that China will begin to carry out various economic reforms (debt reduction, restructuring and strengthening of state enterprises, de-escalation of housing price inflation), which could have far reaching implications for the financial system stability. The problems at the geopolitical level continue to exist. The increase in inflation that would drive up interest rates and the differences in the economic bases in Europe can also bring us problems during 2018.
In general, we believe that the world economy will start the New Year 2018 well, although we do not have to forget about the possible risks that could bring some problems to the economy.
All economic indicators continue to point to a robust global economic growth. Europe is growing faster than other economies at the moment: in the third quarter the Eurozone grew by 0.6 %. This represents a growth of 2.5 % year to date. No wonder, the indexes rush from record high to record high. The all-time high reached in the fall of 2007 has long been surpassed. Cyclical stocks have risen sharply in recent months, but also commodity prices are starting to rise again.
In addition to the existing geopolitical risks, which we have already mentioned in previous comments, we are now also starting to worry about the FED’s potential balance sheet reduction and the possible US interest rate hikes. This could bring some volatility back into the markets. Additionally, we are concerned about the possibility that the ECB may also stop buying securities and start raising interest rates. The boredom that we have seen in recent years in the markets could end at the latest by the end of 2018: Periods of extremely high valuations are often followed by phases of extreme volatility.
Overall, we remain cautios, especially with regard to the highly rated bond markets.
We therefore assume that the current economic and market environment will continue for a few months. However, the list of identified risks remains long. Among them are Italy, which poses a considerable risk to the Eurozone, uncertainties over Brexit, elections in Germany with the various scandals in the automotive industry, the US economy, which could possibly weaken, the euphoria of the capital market after the election of Donald Trump is now flattening out (his policies seem to do nothing except ruffle and Sankdalen), China with high domestic debt and devaluation pressure on the currency and recently North Korea, which, after several rocket launches in recent weeks, recently conducted a sixth nuclear test Has. This can be seen as a response to the annual joint military exercises in the US and South Korea at the end of August. In the short term, we expect further uncertainty and a risk aversion on the financial markets, especially before the North Korean anniversaries, since the Republic was founded on 9 September and the party on 10 October. However, the situation is likely to slow down for some time.
In spite of everything, the capital markets are still rather volatile. Except for currency fluctuations, can hardly see trends at the moment. We continue to watch events carefully and are prepared to respond accordingly.