Market Insights – April 15th, 2019

Weekly financial & economic analysis.

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Black Hole in space

Essentials

The Brexit saga is far from over – the UK parliament failed to agree on a deal and the EU granted an extension until 31 October. There was no reaction from the financial markets, suggesting that they had already priced in this outcome.

US companies are about to publish their Q1 results. The consensus forecast is for a 3% decline in earnings year on year, but we are more optimistic. Investors’ low expectations could mean there are some good surprises, which might push US market indexes to new record highs.

The US yield curve inverted at the end of March, sparking fears of a recession and causing long-term yields to slump on other top-rated government bonds. But these fears were exaggerated. Since then, ten-year yields have once again risen above 2.5% in the USA, edged back into positive territory in Germany and nudged up to -0.25% in Switzerland, from their 27 March low of -0.45%.

The currency war draws on

As global economic growth stumbles and inflation slips yet again, central bankers seem to have embarked on another round of what has become their favourite game in recent years: hot potato. No country wants their currency to appreciate, as that would only handicap their economy and bring in some of the global disinflation. This still-unacknowledged currency war was triggered by the USA in the wake of the 2008 subprime crisis. Back then, the USA did what ever it could not to fall into the jaws of deflation and to dodge the threat of a depression – even devaluating the dollar. Other major economies soon followed suit, starting with Japan and the eurozone.

Since then, countries have been tempted to try and push their currencies downwards each time inflation figures wane. Until just recently monetary-policy normalisation was the name of the game – but now central banks have once again taken an accommodative turn. After biding his time, Fed Chair Jerome Powell finally announced that there would be no more rate hikes. And the ECB said it was ready to extend its ultra-loose policies of the past few years, announcing fresh zero-rate loans for the banking sector starting this coming autumn. The SNB recently lowered its GDP growth and inflation forecasts for Switzerland, based on the assumption that the three-month CHF Libor would remain at around –0.75% for the next three years. The SNB also said that it was not against intervening in the currency market again if needed. Only the BoJ has kept strangely silent so far this year. But we wouldn’t be surprised to hear about fresh measures to keep a lid on the yen. That means the currencies of peripheral and emerging economies are the ones most likely to appreciate. For portfolios denominated in euros and the Swiss franc, dollar hedges are very expensive – but such hedges may not be needed if our predictions are right about the world’s main currencies trending towards an orchestrated equilibrium. That’s provided Donald Trump doesn’t launch a new attack on what he calls the “currency manipulators.”

Europe – US investors to the rescue

European stock markets made a spectacular recovery after their Q4 slump, more than making up for their losses. However, outflows from this asset class have continued, indicating that many investors have chosen to sit out the rally. That is mostly likely because of the weak economic data and Brexit-related uncertainty. But it’s worth noting that sentiment has rarely been so bearish on European stocks; according to Merrill Lynch, most investors believe the region’s markets will continue to underperform, and cumulative fund outflows have returned to the highs last seen in 2012 – at the peak of the eurozone crisis. But it is in this type of situation that opportunities arise. And fresh inflows of funds from US investors – considered as the smartest in the world – in early April suggests that this is the case. If the trend continues, this would provide a major boost to stock markets in the region. Given the paltry income offered by bonds and the expectations for more sluggish economic growth, investors are eagerly seeking returns. And European stocks have an ace up their sleeve: at 3.8%, their dividend yield is currently the highest in the world and represents the widest spread over respective government bonds.

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