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Market Insights – 14th October 2019

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

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Essentials

Government yields rose sharply on both sides of the Atlantic as uncertainties subsided late last week. In addition to low inflation and expansionary monetary policies, this is yet another sign that rock-bottom yields have priced in significant political risk.

With the deadline for a deal between the UK and the EU fast approaching, investors wanted to believe that the British and Irish prime ministers were making headway. The pound bounced back, as did UK stocks, especially in the banking, insurance and property sectors.

The 5% rise in customs tariffs scheduled to be applied to Chinese imports on Thursday has been postponed following US-China talks. But, before they get their hopes up again, investors will need more details in the run-up to November’s APEC meeting in Chile.

The market that fares well in tough times

The global economic slowdown and heightened geopolitical tensions have been a boon for the Swiss stock market, which has largely outpaced global indexes so far in 2019. The SPI significantly outperformed other indexes in both May and August – months in which stock-market volatility rose sharply – as investors made a beeline for Switzerland during these periods of uncertainty.

This was not only because of the defensive nature of Swiss stocks. Despite the difficult climate and weakening economic indicators, Swiss companies have delivered strong results throughout the year, prompting analysts to revise up their earnings growth forecasts for 2019.

But this now means that Swiss stocks are the most expensive among developed markets. For Swiss equities to make further gains from current levels, the global economic climate would have to deteriorate even more, which we don’t think will happen. If economic fundamentals stabilise, or even improve, and trade tensions between China and the USA ease, this could hurt the Swiss market, especially its blue chips, which outperformed small caps over the first nine months of the year.

It is worth maintaining a neutral exposure to Swiss equities given the lack of short-term visibility. These stocks will provide some protection during periods of stress in the coming months. Finally, investors would be wise not to overlook small caps, which are likely to start outperforming if the economic climate improves.

Will we see fiscal stimulus in the eurozone?

After picking up nicely in 2016 and 2017, the eurozone economy is losing momentum. The slowdown has been sharper than would normally be expected in the middle of the business cycle, sparking fears of a possible recession.

The main reason for this is no doubt the renewed political uncertainty, which can mainly be put down to the increasingly difficult trade talks between the USA and China. Things are also strained within Europe, where Brexit-related tensions have had a major impact. Although a recession seems unlikely at this point, eurozone growth is below the target set by the European Commission and inflation expectations are at an all-time low despite the rise in wages.

The ECB has responded to this slowdown by beginning a new round of quantitative easing. This is the right approach, but as the central bank is running out of options, a political move in the form of fiscal stimulus would serve as a welcome reinforcement. And this idea is starting to take hold, especially since the climate is ripe for that kind of stimulus: a number of countries are running a primary surplus and can take advantage of rock-bottom interest rates to fund investment projects. We don’t think investors have priced in the possibility of this type of stimulus, which should provide a boost to eurozone stock markets.

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