Wealth Management: PV Jan – swisspartners – The art of finance

ECB winds down QE

The QE programme started by the ECB in the first quarter of 2015 was a major market event in terms of support for Bond Markets and was expected to run only until the end of Q3 2016. Since then the ECB has spent around €2.5tln (20% of the Government Bond market) on its bond buying program and this helped to push yields down to multi-decade lows.

Whilst this does of course help companies which have borrowed in the debt markets, lower bond yield do mean that many Pensioners struggle to achieve much in the way of monthly income from bonds. This may partly explain why certain segments of the European Consumer & Retail sector have not sparkled in recent years, however, there are definite signs that wage growth may well help boost consumer sentiment next year across Europe.

As 2018 draws to a close, it seems likely that next year will be a challenging one for Fixed Income investors as the bond market is clearly factoring in lower purchases by the Central Bank. In terms of what action investors should take, we would caution against having too much exposure to sub Investment Grade bonds in Europe next year, as we expect yields in this segment of the market to drift higher.

US & China Trade War and possible improvements in tone

The recent decision by the US & China not to escalate their trade war through higher tariffs is clearly good news for investor sentiment. In recent months we have seen signs that fears of higher tariffs had un-settled confidence amongst Chinese car buyers and Global purchasing managers.

However, whilst trade headlines have become slightly more positive during recent trading sessions, comments from President Trump and Commerce Secretary Ross emphasized that they wish China to do more. A more comprehensive set of trade agreements may emerge in the first few months of 2019, especially as the Chinese economy has slowed of late.

Brexit – EU Plays Hardball with May, rejecting pleas for help

Prime Minister May recently went to Brussels hoping to secure some additional “assurances” on the most controversial part of her Brexit deal — the so-called Irish border backstop.

While she made clear that she was not expecting a breakthrough straight away, she urged leaders to do everything they could to make the accord more acceptable at home. However, instead of giving her what she needs, Leaders hardened their approach.

They toughened the language of their communique, taking out some of the most helpful parts that diplomats had drafted in the run-up to the meeting. The pound fell.

There are of course hopes that Politicians will respect the outcome of the first referendum in 2016 and push on with the Brexit process, no matter how painful in the near term that may be.

As usual, other options are on the table and these include the possibility of final amendments in January 2019 by the EU to make the deal more palatable, a new referendum to halt the impasse in Parliament, or even a fresh General election. The current situation is fluid however; the prospect of Britain leaving the EU without a deal still seems unlikely.

Stock markets, computers and opportunities

Why are the Stock market movements so large and unpredictable in the near term? Part of the reason may lie in the fact that the types of participants in markets has changed significantly, as the majority of transactions are now carried out by computers. In addition, it has been exacerbated by momentum/trend following strategies, which effectively buy and sell investments on signals generated. The momentum related trades look to take advantage of the observation that up or down trends tend to persist for some time and an investor can ride on this bandwagon of money flow.

However, in reality such volatility can result in a ‘buy high/ sell low strategy’, which never seems like a sound investment strategy! We would suggest that patient investors can reap benefits from this hap-hazard approach to investment by having a ‘shopping list’ of companies with excellent growth prospects and be ready to pounce and buy quality companies for the longer term at lower levels.

Bond yield inversion and signals

Recent headlines over trade and concerns over the possibility of rising US interest rates have not helped sentiment towards most asset classes. One of the principal causes behind the recent sell off has been the partial inversion of the US yield curve (2 year bonds started to yield more than 5-year bonds). In the past, a full inversion of the US yield curve has been a good indicator of future recessions.

Normally these recession signals are best read from an inversion of the 2-year and 10-year US Government Bond yield. Moreover the signal can in fact relate to a ‘slow-down’ -not a full blown recession and the actual contraction in US economic activity can occur anywhere between 9 – 18 months after the signal has occurred.

As Portfolio Managers, clients often ask us “what should I do?” and our short answer is absolutely nothing if you are a medium or long term investor. Nothing much has really changed. What about all the negative headlines I am reading? Bad news always sells more than good news. If you are in doubt just look at any newspaper.

We are also asked are you still positive? The answer is a resounding yes; for the following reasons:

  1. The inevitable slow-down in the US economy next year is a welcome development. It was growing at too hot a pace before and a slow down to a 2.5% pace is much more healthy
  1. Yes global growth will slow down but is still likely to be in the high 2% low 3% range – hardly a disaster
  1. The oil price has retreated significantly and combined with the slightly weaker US economy this will mean that US interest rates will not rise as fast as expected
  1. We expect no more than 2 rate rises next year and perhaps 1 more this year before we hit the peak of the US rate cycle
  1. The US economy will not go into recession – just a healthy slow down
  1. An Italian budgetary deal with the EU is imminent and will happen before the year end
  1. BREXIT is likely to be soft, cancelled or go to a second referendum
  1. A full trade deal with China and the USA may well happen within 90 days as pretty much all of the demands can be easily met – more than enough to take away the headline risk and both leaders have too much to lose by not doing this
  1. Investor sentiment is at quite a bearish level and most people have given up. This is one of the best contrarian indicators

Written by:
Alan Kinnaird | Senior Portfolio Manager, Partner