BY ERIC VANRAES
Despite early signs of a recovery in Ireland, Spain and Italy, the economic conditions are not improving significantly in the Eurozone with poor growth and low inflation. Growth is a major issue as its poor improvement is disappointing in light of the ‘alignment of the planets’ (low euro, yields, oil and commodity prices) and the European Central Bank’s quantitative easing. Inflation is far from the European Central Bank’s target and unemployment is significant. The influx of migrants might be good for German growth, but anti-terrorist measures and the war against ISIS will cause uncertainty and are likely to lead to higher budget deficits.
US economy ‘not as bright’
Whilst the US economy seems stronger, inflation is higher and consumption is increasing, industry is already in recession and the mid to long-term growth trend will be below that of past decades. We believe the outlook is not as bright as generally thought. Consumer confidence is fragile and if consumption drops GDP will suffer.
China’s growth may have dropped from double digits to around 7%, however this reflects a planned structural change rather than a cyclical downswing. In China, the PBoC could potentially decrease its key rate and/or devalue the yuan further. The economy is rebalancing from investment to consumption and positive relations between China and Great Britain should start to yield results in the year ahead.
Quantitative easing continues
The major central banks (excluding the Federal Reserve and maybe the Bank of England) are still in an ultra-accommodative mode. Massive quantitative easings and negative rates will be implemented.
Until November, the European Central Bank’s quantitative easing represented only 5% of Eurozone GDP, compared to 25% of US gross domestic product (GDP) for the Federal Bank’s quantitative easing and over 50% of Japanese GDP for the Bank of Japan purchase programme. Mario Draghi, President of the ECB, could dramatically increase the European Central Bank’s quantitative easing, if needed, in 2016.
The currency market is, more than ever, a key factor influencing the macro landscape as a result of the combination of more easing in Europe and tightening in the US, which could push the euro-dollar to 1.00 or even below parity. More generally, as many central banks are still in an ultra-dovish mode, including China and Japan, the dollar index (DXY) could extend its rally above 100. This could be a very negative signal for the US economy and for US corporate earnings but is good news for the euro and European corporates. In this context, E.I. Sturdza is extremely cautious on corporate spreads and on liquidity of the credit market. We think that the desperate search for yields above zero leads to excessive risk taking and asymmetric expected returns/loss as hybrid corporates, contingent convertibles, crossover and high yield today offer an equity-like risk profile.
Public sector purchase programmes
Being a shareholder of a sound company offers a better risk/reward profile than being the creditor of a junk corporate. Consequently, E.I. Sturdza favours investments in public sector purchase programmes, i.e. government-owned corporates included by the European Central Bank in its quantitative easing purchase list which, despite their low yields, offer both high quality and liquidity (as the ECB buys EUR 60 billion every month of bonds included in this list). For those who are not convinced that positive returns are achievable with this strategy, take a look at Japanese bond indices performances during the past 10 years.
If the year ahead looks tough then selecting the right stocks and having exceptional professionals manage funds will become ever more important.
- Outside the US, economies will stay weak, central banks will pursue their ultra-dovish policies
- In the US, due to signs of domestic recovery, the Fed will start to normalise its monetary policy…
- …but the first signs of slowdown could appear in the second half of the year and could force the Federal Bank to take a step back
- Yields will stay low almost everywhere, the US curve will be flatter
- China will not implement quantitative easing, but will decrease its main rates sharply
- Inflation will stay low, but be aware of the base effects due to commodity prices
- The USD should be stronger but the trade is massively crowded
- A positive surprise could come from an emerging bond market recovery (both in local and hard currencies)
The article was also published in Business Brief.
Disclaimer: E.I. Sturdza Strategic Management Limited, part of the Sturdza Private Banking Group is authorised and regulated by the Guernsey Financial Services Commission to provide investment management and advisory services, with registration number 35985. The Strategic Euro Bond Fund and the Strategic Global Bond Fund are sub funds of E.I. Sturdza Funds plc, an Irish domiciled fund. The views and outlook expressed are those of the Portfolio Manager, Eric Vanraes, associated with the Fund and are valid and constructed in light of prevailing market conditions. This material does not constitute a recommendation or offer to buy or sell shares and past performance is no guarantee of future results.