Investment Outlook 04.2016
Thomas TrauthEconomist, Dr. rer. pol., CFA, FRM
Outlook for earnings may not be as bad as anticipated
In March risky assets recovered noticeably. Emerging equity markets gained 13%. The Brazilian Ibovespa index even rose 17% in March, followed by the Chinese CSI300, which rose 11.8%. The US S&P500 index was up 6.6%, outperforming the German DAX, which was up by 5%, and the EuroStoxx50, which was up by 2%. The Japanese Nikkei225 index rose 4.6% but remained the laggard regarding year-to-date performance. The Nikkei 225 lost 12% in the first quarter.
Risky bonds, especially emerging market bonds and high-yield bonds, performed very well in March.
Government bonds initially sold off but recovered markedly after the meetings of ECB and the Fed mid-March. 10-year German government bond yields fell as low as 0.08%, very close to their all-time low in April 2015.
Commodity prices recovered in March. Especially the oil price increased and reached 42 USD/bl mid-March, only to decline thereafter. Still, at the end of March the oil price was about 7% higher than in February. Gold was very volatile and ended the month 0.5% lower than end of February.
Despite a very dovish ECB the EUR strengthened across the board, while the USD weakened vs. most major currencies, especially after the Fed meeting announcing that rates would only be raised very moderately. Currencies of commodity producers and of emerging markets were mostly up in March due to more buoyant sentiment regarding emerging markets and rising commodity prices.
The increased optimism is also apparent in falling volatilities. The VIX index (implied equity volatility) has halved since mid-February and is currently at about 14. Also, the MOVE index (implied fixed-income volatility) fell from 98 mid-February to around 70. This means that the demand for insurance against falling markets has come down considerably.
Mid-March the ECB decided on a bundle of additional policy measures to support the economy. It cut rates even further, e.g. the deposit rate by an additional 10 basis points to -0.40%, while it increased its bond-buying program from EUR 60 bn to EUR 80 bn per month and introduced a new series of four targeted longer-term refinancing operations (TLTRO II) to encourage bank lending.
Shortly after the ECB announcement, the US Fed also communicated its intention to stay accommodative for longer and it revised the likely path of future interest rate hikes downwards.
As a result, the equity rally gained additional pace and bond markets reversed their sell-off. US and German 10-year government bond yields have fallen by more than 20 basis points.
Growth indicators improved for most major economies in March. The US ISM index jumped clearly above the recession level of 50 to reach 51.8 in March after 49.5 in February. Also, non-farm payrolls continued to be strong. The US economy created another 215,000 jobs in March.
The European PMI rose to 51.6 from 51.2. The German IFO business climate indicator advanced to 106.7 after 105.7.
The Chinese manufacturing PMI managed to go beyond the critical 50-level to reach 50.2 after 49.0 in the previous month. In addition, the Chinese non-manufacturing PMI increased to 53.8 from 52.7.
However, the Japanese PMI fell markedly to 49.1 from 50.1 in line with weak equity markets and indicating the current frailty of economic conditions in Japan.
Expectations for the upcoming earnings season are very negative, with forecasts that US EPS (earnings per share) will fall 5-10% year-on-year. This will largely reflect very low earnings in the energy sector, caused by the oil-price slump and the strong USD in 2015. However, both factors have eased recently and there will be some improvements in the coming quarters. Furthermore, earnings in the non-energy sector show a very robust positive growth trend. As a result, while we expect weak earnings overall, this should not overcloud our medium-term more positive outlook for the US corporate sector.
Our outlook remains more or less unchanged. We are in a low-growth phase, with a high likelihood that this will prevail for quite some time. Huge monetary stimulus will most likely keep the economy and financial markets afloat. But inherent economic macro growth will continue to be depressed by mounting macro risks, large overcapacities and ongoing de-leveraging.
We believe, however, that commodity prices may stabilize, though there is limited upside potential due to the continuing large oversupply in many commodity sectors.
In our view, the rising US core inflation will make it logical for the Fed to pursue a very cautious hiking policy, with about two rate hikes in 2016. This will cause renewed volatility, possibly with further corrections of markets for risky assets.
The USD will stay range-bound for some time but is likely to strengthen again when the Fed decides to hike rates later this year.
Despite our outlook for the US Fed we have become more positive for emerging markets. The year-to-date outperformance and the attractive valuations have convinced us to upgrade our outlook for this asset class.