Investment Outlook 05.2018
Thomas TrauthEconomist, Dr. rer. pol., CFA, FRM
April recovery despite geopolitics
In April, despite the unclear situation regarding US-Chinese trade relations and the future of the Joint Comprehensive Plan of Action (Iran unclear deal), equity markets rebounded noticeably. However, we observed diverging equity market movements. Emerging markets equities fell 0.6% in April, driven by Chinese equities, which sold-off by 3.5%. The US S&P500 index was about flat, ending the month 0.3% higher. Meanwhile, the EuroStoxx50 surged 5.2% and the Japanese Nikkei225 4.7%. European and Japanese equities were supported by weakening currencies, the EUR fell 2% vis-à-vis the USD and the JPY almost 3%.
The sudden rise in USD strength, which started mid-April, was remarkable. Convincing explanations for the sudden USD bounce are lacking. The USD is certainly supported by stronger US growth, compared to most other regions, and a clear yield advantage. In recent weeks the yield differential widened even further, to more than 300 basis points based on 2-year yields. However, both of these factors had been present for some time, during which the USD weakened month after month. Some analysts argue that markets have started to re-focus on fundamentals, which will lead to a much stronger USD over the coming months.
For fixed income markets the major development was the strong rise in US yields, especially after the Fed rate hike on 21 March.
Higher US yields and a stronger USD generated strong headwinds for emerging market assets. Local currency bonds lost 3% in April and hard currency bonds 1.5%. In contrast, high-yield bonds gained moderately, by 0.2%. Energy-related companies are an important part of the high-yield index. Therefore, higher oil prices have certainly helped the overall performance.
Global REITS recovered strongly, gaining 3.5% in April. European and Asian REITS outperformed. In our view, REITS have suffered too much from rising yields in recent months, since in the current environment REITS should be able to profit from rising rental income.
Commodities surged in April. The broad Bloomberg commodity index climbed 2.6%, driven by oil, up 7%, and metals, up 3.5%. Gold fell 0.8% and was unable to benefit from either geopolitical tensions or from rising inflation.
In Q1 global growth slowed. US GDP growth fell to 2.3% after 2.9% in Q4. EMU growth also fell to 1.6% after 2.8% in Q4. This is consistent with falling PMIs, after a peak in late 2017 (EMU) and early 2018 (US).
US non-farm payrolls rose to 164,000 in April and the unemployment rate fell below 4% for the first time since 2000. The US economy continues to create jobs at a strong pace.
US inflation accelerated in recent months, reaching 2.5% in April. Most notably the personal consumption expenditure core price index (PCE) rose to 1.9% in March, after 1.6% in February. This is an important indicator since it excludes volatile seasonal food and energy prices and is closely monitored by the US Fed. Average hourly earnings, however, rose only slightly to 2.6% yoy, suggesting there is still no significant wage pressure building.
On 26 April the ECB kept rates unchanged and did not alter its wording. It will maintain its asset purchase program at the current pace of EUR 30 bn per month until at least September. It is widely expected that the ECB will reduce its asset purchase after September. More guidance on the further tapering measures are expected at the ECB’s policy meeting on 26 July.
On 2 May the US Fed kept rates unchanged. It confirmed that inflation has risen to almost its 2% target. That would mean, in our view, that the Fed is likely to accept a certain overshoot of inflation above the 2% target. The market fully prices another rate hike at the Fed’s next meeting on 13 June.
We reduced portfolio risks at our last Investment Committee meeting, due to heightened geopolitical risks, especially a potential trade war between the US and China. We lowered our equity exposure to neutral and slightly reduced credit risks. We remained positive on the outlook for commodities, especially energy, due to robust growth, rising inflation and geopolitical tensions.
So far markets have remained relatively calm after the US decision to exit the Iran contract. However, we remain cautious regarding the long-term implications and especially the impact on the US-European relationship. In addition, it is very possible that US President Trump will decide to take a tough stance and introduce massive tariffs on Chinese export goods.