31st October 2019

Financial markets dialogue for the fourth quarter

Marc Fohr, Head of Investments at BCEE Asset Management (now Spuerkeess Asset Management), considers the current economic climate.

We read in the press that the global economy is slowing down. Is this really the situation?

Growth remains solid in the US: it is being driven by domestic consumption and public spending, but slowed by private investment and exports. The tariff war is disrupting international trade flows. As a result, companies baulk at making investments. It is, however, not unreasonable to remain optimistic: the US economy will stay on track this year.

Unemployment is historically low (3,7%), wages are growing and inflation remains subdued.

In Europe, economic growth is faltering, boosted by domestic demand but slowed by exports. Growth in the region has fallen from an annual average of 2,3% to 1,1% at the end of the second quarter of 2019. Within the EU, Eastern European countries are setting themselves apart: their average annual growth rate is now 3,5% (Baltic states), while growth rates in Hungary, Poland and Romania exceed 4%. In the North, the Netherlands, Denmark and Finland are doing well. The situation of the major economies is more mixed: France is doing reasonably well, while Germany has fallen back into negative territory.

Economies are not doing too badly, but central banks are cutting their key rates. Why is this?

We should see this approach as a preventive measure. The idea behind this cut in interest rates is to preserve accommodative financial conditions and prevent them from tightening as a result of the heightened volatility on the financial markets. If we cast our minds back to the beginning of 2019, many analysts forecast several interest rate hikes, but the ongoing weakness of inflation and doubts created by trade tensions have prompted central banks to fundamentally change their discourse.

The Fed implemented two 25 basis points cuts, and the trend points to another downwards movement, if any. In addition, given that the effect of monetary policy on the real economy is subject to a delay of several months, waiting for the economy to deteriorate before acting would have been counter-productive.
Marc Fohr
How has the European Central Bank (ECB) reacted?
How has the European Central Bank (ECB) reacted?
ECB President Mario Draghi has announced a series of major new developments. First of all, the deposit rate was cut from -0,40% to -0,50% to encourage banks to lend more and provide the economy with fresh impetus. Then, banks were allowed to benefit from a system that exempts a proportion of their deposits from negative rates, plus a series of modifications to their targeted longer-term refinancing operations. Finally, the asset purchase programme was relaunched at EUR 20 billion a month, and will last as long as necessary.
How has the bond market reacted to this news?
How has the bond market reacted to this news?
Interest rates in peripheral European countries have plummeted. In Italy, risk premiums took longer to contract owing to the volatility created by political instability. The search for yield is another force at play behind the sustained demand for private debt: numerous insurers and pension funds have been impacted by rate constraints that have pushed them towards assets that are riskier than sovereign debt, which is now posting predominantly negative rates.
What will the consequences be for equity investments?
What will the consequences be for equity investments?
The risk is mainly political: the tariff war and the uncertain outcome of Brexit are injecting volatility into the equity markets, because the negotiations could take a number of different directions. Growth expectations for earnings per share only stand at 2%, and we believe consensus estimates will be revised downwards. We are aware that every complex situation harbours opportunities and are therefore adopting a defensive approach and are looking to benefit from the growing volatility. At sector level, we continue to avoid raw materials and semiconductors. We are opting for communication services and real estate: the former sector offers the advantage of being exposed to resilient stocks (telecoms operators) and growth stocks (internet giants), while the latter benefits from its defensive nature, an environment of low rates and particularly attractive valuations.

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Panorama Financier 2018-04