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Market Insights – 3rd of June 2019

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

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Essentials

While other stock markets around the world struggled, the SPI hit a new record high last week. And Swiss GDP growth in Q1 came in well above analysts’ forecasts, at 1.7%. This is further proof of the domestic market’s defensive nature, which makes it particularly attractive when global economic growth falters. 

Chinese manufacturing output held steady in May. The Markit/Caixin Manufacturing PMI stood at 50.2, unchanged on the previous month and above expectations. But the upward trend in exports could well be reversed if trade relations between the USA and China deteriorate.

The drop in oil prices has quickened in recent days, owing to uncertainty about demand. From a technical standpoint, prices have fallen below their moving average, suggesting that the rise that began last December has been interrupted.  

Can we escape Thucydides's Trap?

Thucydides was a politician and historian who lived in Athens in around 450 BC. He penned The History of the Peloponnesian War, in which he recounts the war waged between Athens and Sparta during his lifetime. For Thucydides, it was Athens’s rapid rise that led to the conflict, as it posed a threat to Sparta’s power. Graham Allison, a US political scientist, coined the phrase “Thucydides’s Trap”. He says that when a rising power threatens an established power, the result is usually war, and he can cite a dozen or so examples from history. Allison thinks that the current situation between the world’s two superpowers is another example.

China’s recent rapid rise could well challenge the USA’s world domination in a few years’ time, on the economic, technological and military fronts. The vast arsenal of deterrents held by both sides means there is little risk of a military confrontation. But there are other ways that the USA might seek to rein in China’s development. The trade war seems to be one of them, if the customs tariffs brought in by Donald Trump are anything to go by. Another is the USA’s desire to hold back China’s technological progress by making things difficult for Huawei, the country’s leading tech company. As expected, China has fought back with further tariffs and has threatened to cut back its exports of rare earth metals, which are crucial to US tech companies. It’s no surprise that the financial markets have not reacted well to these developments. The sharp decline in stock markets, bonds yields and oil prices in recent days are a sign that investors fear that these measures will have a major economic impact and could even cause a recession. But it’s worth remembering that Donald Trump’s time horizon is much shorter than that of China’s leaders. The president’s re-election will depend on the strength of US economic data – particularly in terms of employment – and Wall Street’s performance. These considerations will no doubt keep Mr Trump in check when it comes to deploying his trade-related weapons. But what will happen if Donald Trump is re-elected?

Eurozone stock markets – the place for investors seeking yield

After a very buoyant first quarter, there has been some profit-taking on eurozone markets as a result of political uncertainty. And there’s no shortage of reasons for this unease. Firstly, investors are concerned about the fallout of the trade talks between the USA and China. And secondly, within the EU, which seems to be increasingly divided, Theresa May’s resignation means that the Brexit turmoil will continue, and Italy’s government has maintained its stubborn stance towards Europe. It’s difficult to hold any strong convictions in the short term, but we do think that there are still some longer-term opportunities.

The economic slowdown and persistently low inflation have prompted central banks to adopt a more accommodative stance – and that’s especially true of the European Central Bank. This has caused bond yields to fall to new record lows, making it even harder for investors to generate returns. Safe stocks offering high dividends should therefore become increasingly appealing. EU equities are currently delivering a return of 3.8% and have rarely been so cheap relative to bonds – the spread between stock and bond yields is the widest it’s ever been. And fund outflows show that expectations for the eurozone remain low, even though the region has just recorded one of its best earnings seasons in recent years.

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