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Market Insights – 29th of July 2019

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

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Essentials

The IMF cut its global growth forecast for 2019 to 3.2%, down from its April estimate of 3.3%, as US-China tensions or a no-deal Brexit could slow growth, weaken investment and dislocate global supply chains.

Shanghai’s STAR market kicked off last week, with the first group of 25 companies gaining 120%. The aim of the “Chinese Nasdaq” is to encourage tech companies to come to or stay in China. It is still too soon to invest, but this market could in time make a place for itself.

US GDP grew by 2.1% in the second quarter. While this figure was slightly above the consensus, it came as no major surprise. GDP growth stood at 3.1% in the first quarter, meaning that the US economy expanded by around 2.5% over the first half of the year.

Positive yields are hard to find

This business cycle is certainly an unusual one. A few months ago, most central banks were hoping to follow in the Fed’s footsteps and begin gradually normalising their monetary policies after more than ten years of aggressive stimulus measures. But central bankers’ hopes have been dashed, as the global economy has been hit by trade tensions and inflation has started to slide almost everywhere.

So weare back to monetary easing once again. The Fed chair and the ECB president have both warned that rate cuts may well be on the horizon. And given that interest rates are already at rock bottom in Europe, we cannot rule out the possibility of further quantitative easing as well.

Bond investors are well aware of the situation: they know that interest rates are not going to rise any time soon, especially in Europe, where long-term yields are at all-time lows. What seemed unbelievable some years ago has more or less become the norm. You now have to pay for the privilege of lending money to some of the safest sovereigns in the world. Over a period of ten years, it would cost 0.4% a year to invest in German Bunds and 0.7% a year to invest in Swiss government bonds. Yields are below 1% on almost half of all sovereigns around the world and in negative territory on more than a third.

Worldwide, interest rates are negative on USD 14 trillion in bonds. Given these less-than-appealing conditions, and provided the business cycle continues and the global economy does not fall into a recession, we think it is worth investing in higher-yielding bond segments, such as investment-grade corporates and emerging-market bonds, even if they are riskier. As central banks try their hardest to lessen the appeal of bond investments, stock markets are the ones expected to outperform. But given that valuations are running high on some markets, like those in the USA and Switzerland, and after their stellar performance in the first half, we do not expect equities will do as well in the second half of the year.

Europe – Let’s meet in September

The European Central Bank held a much-awaited meeting last week. Mario Draghi signalled his intention to cut rates and bring in further stimulus measures later in the year, probably in September. The financial markets had a mixed reaction to the news – the ECB remained vague on the details of its upcoming moves, which left many investors wanting more.

But the latest economic data from the Eurozone and the political risks the region is exposed to justify actions by the ECB. The Manufacturing PMI reached its lowest level since the financial crisis, with Germany faring particularly poorly, and the IFO indicator hit a nine-year low. Now that Boris Johnson has become the UK’s prime minister, the risk of a no-deal Brexit has increased.

Yields are extremely low across the board – ten-year bond yields are already negative in Germany, France, Sweden, the Netherlands and Switzerland – so there is little room for manoeuvre when it comes to interest rates. But the ECB still has unconventional weapons it can use. We think Mr Draghi, who will soon be leaving office, is likely to announce a raft of asset purchases in September, which would be good news for the financial markets. Against this backdrop, bond yields will probably remain at rock bottom, strengthening our conviction about the appeal of stocks versus bonds in Europe, as the gap between stock and bond yields has never been so wide. And another record figure – the 70 consecutive weeks of net outflows on European equity funds – suggests that sentiment on European stocks is far from euphoric.

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