Investment Outlook 05.2019
Thomas TrauthEconomist, Dr. rer. pol., CFA, FRM
Trade war escalation?
The equity market rally continued in April and some equity indices, like the S&P500 and the Swiss SMI, reached new highs. The German Dax outperformed and rose by 7.1%, followed by the US S&P500, rising 3.9% and the MSCI Europe, climbing 3.2%. Emerging markets underperformed; the MSCI Emerging Markets rose by just 2%. The rally was fueled by decent US growth, continued credit expansion in China, and Sino-US trade talks, which seemed to be proceeding positively. In early May, however, after President Trump announced his intention to impose tariffs on Chinese goods, the CSI 300 fell sharply, and most other equity markets corrected as well, albeit by much less.
The bond-market rally in March reversed in April. Bond yields rose by about 10 basis points in the US and in Europe. This move was mostly driven by rising inflation expectations. As a result, yield curves steepened.
High-yield spreads tightened in April, which pushed the high-yield performance index up by 0.7%. Emerging-market bonds had a more difficult month. Hard- currency bonds rose 0.25%, whereas local-currency bonds fell slightly, by 0.18%.
After the US announced on 22 April that it was not extending its six-months waivers, which allowed eight countries to import oil from Iran until early May, prices for Brent oil surged further to reach almost USD 75 per barrel. However, better US inventories and growth concerns led to falling oil prices thereafter.
The gold price fell slightly, by 0.7%. REITS gave back some of their previous gains in April. Listed private equity continued its remarkable rally, and rose by almost 23% year-to-date.
Most currency majors remained unchanged in April. The CHF, however, weakened vis-à-vis the EUR and gave back most of its March gains. The TRY came under strong selling pressure after political tensions rose when president Erdogan nullified the result of the mayoral election in Istanbul, which the opposition had won.
In April global PMIs remained on the weak side. The US ISM index fell to 52.8 after 55.3, the EMU PMI rose slightly to 47.9 after 47.5, and the Chinese PMI fell to 50.2 after 50.8. Meanwhile US GDP growth remained robust and rose 3.2% QoQ annualized. US non-farm payrolls rose by 263,000 in April, which clearly exceeded expectations. Meanwhile, average hourly earnings rose by 3.2%.
US Inflation rose to 2.0% from 1.9%, but was below expectations. Strong US productivity gains can partly explain the continued softness of inflation. EMU inflation rose to 1.7% after 1.4%, the March reading probably having been depressed by an Easter effect.
At its 30 April to 1 May policy meeting, the Fed kept rates unchanged. The Fed said it will be patient in determining the next future adjustment of the target range for the federal funds rate. Fed chairman Jerome Powell said that he considers the policy stance appropriate, as solid fundamentals support the economy. Earlier Jay Powell pointed out that he sees the current softness of inflation as rather transitory. Those comments support our view that a Fed rate-cut appears to be very unlikely unless the US economy should start stuttering unexpectedly. Before the policy meeting the Fed came under renewed pressure from President Trump, who openly asked the body to cut rates.
At its policy meeting on 10 April, the ECB reiterated its accommodative policy stance, including the introduction of a new series of targeted longer-term financing operations (LTRO-III). Meanwhile, inflation expectations, as measured by the five-year, five-year inflation swap rate, fell to a three-year low at 1.35%. This is an important measure for long-term inflation expectations and could encourage the ECB to stay accommodative for longer. The next ECB meeting is on 6 June, when the ECB will update its macroeconomic projections. This meeting may turn out to be very decisive for the future path of monetary policy in Europe.
The major risk for global growth and financial markets is an escalation of the Sino-US trade dispute. After President Trump announced his intention to raise tariffs on 5 May and when trade talks on Friday, 10 May, failed to produce a result, the US raised tariffs on virtually all Chinese imports to 25%. China announced retaliation measures. So far it is not clear what those measures will look like. Nevertheless, it seems that both parties expressed their willingness to continue the trade talks. It looks as if both sides should have strong incentives to solve the trade dispute. Nevertheless, there is considerable risk that negotiations could end without resolution and that the trade war will escalate, with negative consequences for world trade, growth and financial markets. Overall, we still see a higher chance of a positive outcome, since it is in the vital interests of both sides to avoid a full-blown trade war.
In addition to the trade dispute other geopolitical risks loom. The US could decide to intervene in one way or another in Venezuela. The conflict with North Korea is still boiling. Furthermore, tensions between the US and Iran have risen recently, after President Trump ended the waivers allowing eight countries to import Iranian oil. Iran announced it would no longer feel bound by the deal which limits Iran’s nuclear program in return for economic relief. The US has sent an aircraft carrier strike group to the Persian Gulf.
The recent market reaction, a merely moderate sell-off of developed equity markets, seems to suggest that markets assign a higher probability to successful trade talks.
On the back of the above-mentioned political uncertainties, we remain cautiously positioned. The equity hedge gives us additional downside protection. We have not recently changed our tactical asset allocation.