In September, the equity markets recovered slightly after experiencing a relatively difficult August. However, with a rise of less than 2%, the previous month’s losses were not completely wiped out. The political framework remains turbulent and provided no respite for investor sentiment. The impeachment proceedings against President Donald Trump brought by the House of Representatives and the Senate can be added to long-standing issues, such as the trade war, Brexit and tensions in the Middle East.
However, the markets remain fairly confident and the likelihood of a recession remains remote.
Based on the Atlanta Fed’s estimates, the GDPNow indicator estimates that the US economy is currently growing at more than 2%, which is considered to be the long-term growth rate.
As we predicted last month, the central banks did not disappoint. They seem to be playing their preventive role to the full in the sense that they are intervening fairly aggressively, despite the fact that macroeconomic data does not yet point to an imminent recession. Note the two rate cuts in the United States, and especially the European Central Bank’s (ECB)’s new, rather ambitious asset purchase programme (Quantitative Easing), which is expected to last until “shortly before the next rate hike”. The intention of these accommodative monetary policies is primarily to provide relief in a political environment that remains very unpredictable, and to avoid an unintended tightening in financial conditions.
At the same time, economic growth expectations are not improving. The Organisation for Economic Co-operation and Development (OECD), in its Interim Economic Outlook, expects a growth rate of only 2,9% this year, compared to 3,6% last year. The revision is significant when compared with the position in May, when the OECD still expected an increase of 3,2% in overall gross domestic product. The scapegoat of this deceleration is none other than trade tensions.
The economic outlook remains weakened by an unstable political environment. We cannot therefore ignore the risk of volatility on the equity markets in the coming weeks, especially ahead of the Brexit deadline. That is why we prefer to take a cautious approach, maintaining our slight underweighting on equity markets in the short term.
Equity markets continue to reach new highs. In September, performance was strong in Europe and slightly positive in the US. The support of the central banks and abundant liquidity are the main reasons for this strong growth. Nevertheless, in-depth analysis reveals that the situation is much less rosy than it appears: the scale of the increase is restricted to a minority of stocks and significant inter-sectoral movements. In this regard, we note in particular the weakness of cyclical sectors (Energy and Materials) and the movement towards sectors considered defensive (Utilities, Consumer Non-Discretionary and Real Estate). Once again, valuations were not a differentiating criterion and sectors that were already expensive continued to increase in value.
Investors should pay particular attention to three factors that are likely to influence stock markets in the coming months. First, the rise in the dollar could be damaging to international trade and for emerging markets whose debts in this currency are the most significant. Secondly, the fall in the price oil, which continues to weigh on the Energy sector. Finally, the rise in gold prices, which stabilised at high levels and could signal both a higher perception of risk and an opportunity for gold companies.
The economic slowdown, the fall in global trade flows, uncertainties associated with Brexit and Trump’s impeachment process as well as relatively high valuations are encouraging us to adopt a cautious approach and take advantage of any future corrections when investing liquidity.
In terms of sector preferences, October began with the conviction that the Real Estate sector would continue its strong performance, driven by low interest rates and a good dynamic in the services sector.
Also, the Consumer Services sector remains one of our favourites due to its earnings growth (particularly those of internet and media companies) and dividend stability (telecom companies). We are staying away from low-growth sectors such as Utilities and Materials. Finally, we are maintaining our negative view of the semiconductor segment: these stocks are the most volatile in the IT sector and are expected to suffer from the current economic slowdown.
On 12 September, the ECB sent the strong signals that had been long-awaited by market participants. Mario Draghi announced a large number of accommodative measures: a reduction of 10 basis points in the deposit rate, a tiering system for bank reserves, the resumption of the asset purchase programme at the rate of EUR20 billion as early as November and without any time limit and, finally, more favourable terms for the new series of quarterly targeted longer-term refinancing operations (TLTRO III). Although the size of the fall in the deposit rate is disappointing, it is largely offset by the ECB’s expectations, particularly in terms of inflation, which could justify the net purchase of assets beyond 2021.
On 18 September, the US Federal Reserve (Fed) cut its key rates by 25 basis points and pointed to the same scenarios it described only two months earlier, but its Chair did not provide further details of the future direction of monetary policy. However, based on projections, a rate cut by the end of the year is still likely.
Given the downward trend and historically low rates in Europe, investing money in a money market instrument denominated in euros is not an attractive option for investors.
In the credit market, September saw a continuous widening of risk premiums before changing direction at the end of the month.
The instability of the asset class should be viewed against a backdrop of a febrile economy. The challenge of economic growth is particularly relevant to the credit markets as corporate balance sheets remain the weak link in this cycle. However, market participants can rely on reactive central banks that are not reluctant to use the tools in their armoury, such as the ECB, which recently announced the resumption of its asset purchase programme, which is set to be long-term and should support demand for the asset class.
Indeed, the ECB’s asset purchase programme will further underpin demand for private debt. Against this same backdrop, the area of negative-yielding debt is predominant. As a result, institutional investors such as insurers and pension funds that are subject to interest rate constraints are turning more towards private debt in order to offset low or even negative sovereign rates.
Consequently, in our opinion, credit will continue to be an attractive asset class despite fears around the economy, as demand is likely to remain high. However, we believe it is better to favour low-cyclical, high-quality companies and to opt for highly liquid vehicles.
In September, the dollar continued to gain ground against the euro. The various accommodative monetary measures announced by the ECB increased the yield spread between the dollar and the euro, which weakened the European currency. In addition, the deterioration in the zone’s macroeconomic data further accelerated the euro’s losses against the dollar.
This is evidenced by declining industrial production in the main eurozone countries and by some leading indicators of decline, such as the ZEW, which measures the confidence of German investors.
The two central banks will meet at the end of October: the ECB on 24 October, and the Fed on 30 October. The financial markets do not expect rates in the eurozone to change. Moreover, the President of the ECB will leave his position on 31 October, leaving Christine Lagarde to take up the challenge of economic recovery. By contrast, investors expect a further reduction of 25 basis points in the US.
We share these expectations and consider that the impact on the euro-dollar exchange rate will remain small. As a result, the EUR is unlikely to fall below the 1,05 mark. Moreover, it does not seem likely that the EUR will appreciate to more than 1,15 because the economic climate in Europe is less positive than in the United States. The 3 October deadline for Brexit could lead to chaos on the border or serious disruptions to trade flows, which could increase interest in safe haven currencies, and could bring the euro closer to parity against the dollar.
In September, gold prices fell slightly, while remaining fairly stable and at high levels (month-end at USD1.470 per ounce). We do not believe that this recent fall is a source of concern, as the structural reasons for investing in precious metals remain unchanged:
the demand from central banks, which need to diversify their reserves, the growth of the middle classes in developing countries, the volatility in currency prices (which makes gold a prized investment due to the stability of its equivalent value in dollars) and above all its safe haven features that benefit from the potential volatility of stock markets.
Gold is also an asset that does not generate any yield (no dividends or coupons are paid on gold bars), and as such, gold has an opportunity cost compared to equities and bonds. In this environment of low or even negative rates, this opportunity cost is minimised, which makes the metal more attractive.
We believe that gold prices can remain in the USD1.490-1.550 range and are even more positive in the medium term. We consider that one of the best ways of taking advantage of this situation is not only to physically hold gold or securities, but also to invest in gold companies whose operating leverage should lead to a rise in the price of gold.
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