Market Insights – March 11th, 2019

Each week, a team of experts shares its market views with you.

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Essentials

While US manufacturing output lost steam in February, the ISM services index ticked back up and almost reached its recent high of 59.7. This is a good sign for the US economy, as the services industry accounts for a large portion of GDP.

Given its broad domestic exposure, the Indian economy is only weakly correlated with that of the rest of Asia. Its manufacturing PMI went from 53.9 in January to 54.3 in February, its highest level since December 2017. The market is catching up, but risks remain in the run-up to the general election, which starts in April.

The UK financial markets seem to expect Brexit to be postponed beyond the 29 March deadline. There will be several key votes this week, which should clear up some of the uncertainty.

 

Is financial repression the new norm?

Savers have not fared well in Europe in recent years. It’s impossible to get a decent return on a safe investment. This is because of the financial repression put in place after the 2008 subprime crisis. Financial repression is often described as a gentle way of confiscating savings. The aim is to encourage investors to accept interest rates that are well below the rate of inflation to help reduce the country’s national debt. While the aggressive stimulus policies adopted in recent years were first and foremost designed to shore up the economy, the result is the same – savers have been left out of rocket for many years now. In Switzerland and elsewhere in Europe, bank accounts rarely pay interest, and customers are sometimes even charged negative interest. The bond market is no more appealing; if you’re looking for a safe long-term investment, ten-year yields on German sovereign bonds are close to zero. And it’s even worse in Switzerland, where investors have to pay negative interest of 0.4% for the privilege of lending money to the Swiss government for a decade. What’s worrying is that the situation looks set to last much longer than expected. Although the current macro cycle is not yet at an end, it’s inevitably getting closer to it. In the USA, for instance, the cycle is already showing signs of maturing. The country is close to full employment and wages are starting to pick up. China, the other driver of the world economy, may see its economy slow after numerous years of robust growth. The window for normalising monetary policy seems to be about to close, just as the European Central Bank is looking again to support the economy through long-term bank loans. And other central banks in Europe are following suit – starting with the Swiss National Bank. Unappealing bond yields will continue to push investors towards riskier assets. Given the current uptick in economic growth and low inflation, stock markets still have upside potential this year. But here too, the window will inevitably close at some point.

The ECB's U-turn

The ECB, which only brought its quantitative easing to an end in December, took the recent downturn in the eurozone’s economic indicators very seriously. At its latest meeting, it announced that it had considerably revised down its growth forecasts for this year. Furthermore, it won’t change interest rates before the end of the year, and, to boost lending, it brought in a new programme of targeted longer-term refinancing operations (TLTRO). But the markets largely expected these measures – the announcements triggered profit-taking following the market’s sharp rise since the start of the year.

Despite this lacklustre economic climate, it’s worth noting that European stock markets have not been underperforming relative to the rest of the world for six months now, probably because investors are being very cautious in terms of their exposure. This is illustrated by the massive outflows of funds from the region and the spread between stock and bond yields, which is at a 70-year high. So expectations for both the stock markets and the economy are extremely low. But in recent weeks, economic newsflow has improved, which could be a sign that the worst is now behind us. In addition to the accommodative monetary conditions, higher wages and fiscal stimulus will boost growth.

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