Another Period Of Risk Aversion
At the beginning of August, a new downward phase in the stock markets began, triggered by further tensions in Sino-US relations and the threat of a 10% tax on USD 300 billion of Chinese products imported into the US from September onwards. The end of the Osaka truce between the Chinese and US presidents has had an immediate impact on risky assets. The Renminbi has just risen above 7 against the dollar and the Chinese authorities have announced a freeze on purchases of US agricultural products.
Added to these trade tensions are other political concerns, including a) the Brexit issue, with Mr Johnson's new approach and the higher probability of a hard Brexit (no agreement with the European Union); b) political problems in Hong Kong, serious issues for the Chinese authorities although they are unlikely to have a major economic impact; c) tensions between Iran and the United States.
The latest economic figures are not likely to extinguish these political concerns: for example, the US jobs report released on Friday 2 August depicted a strong labour market, with full employment and a rise in wages (+3.2%). But, on the same day, leading economic indicators (manufacturing ISM and PMI) revived worries about the lack of growth in the manufacturing sector. Similarly in Europe, the figures published in recent days were weaker than generally expected.
For the financial markets, these economic data are not a surprise since they explain the latest decisions of the central banks: the Federal Reserve cut rates on 31 July, as expected, and the ECB announced further monetary accommodation measures that it would implement in the autumn.
The escalation of trade tensions between China and the United States is therefore another issue that central banks will not be able to address before their next meetings in September. During the month of August, expectations of further rate cuts are growing; the markets are now pricing in (with a 100% probability) another Fed rate cut in September.
All bond markets are impacted by this risk aversion movement: bond rates have fallen massively. The whole German yield curve is in negative territory (even the 30-year yield!). The total amount of bonds that now trade at negative rates is USD 14.5 trillion, 50% of which are in the eurozone (see Edouard Desbonnets' flash dated 23 July entitled ‘Negative yields are spreading. Will this aberration become the norm?’).
This movement in the bond markets surprises us by its scale.
We are not changing our prudent investment strategy and remain negative in the short term on equities, and on the whole asset class. We have been recommending profit-taking since the beginning of June as downward revisions of corporate profits, in our view, warrant more moderate valuation ratios. In the long term, we are neutral as we do not expect a global recession. We continue to favour a defensive strategy, sector-wise (health care, real estate) and in terms of stock-picking. Caution remains justified as market tensions are not yet extreme. The above-mentioned uncertainties will last.
One hedge we recommend is gold.
We remain positive on the yellow metal. Its rally is especially remarkable as the dollar has remained strong. With interest rates so low, we still favour holding gold as the cost of carry is cheap. Gold makes it possible to reduce portfolio volatility via diversification.
For us to change our view and become more positive, the financial markets would need to post a deeper and longer correction so that indices return to their long moving averages. Another condition is that economic policies are being adjusted more significantly to this low-growth environment. However, central banks do not have much ammunition since rates are already very low. Tax policy would therefore need to take over. One country we are following in particular is China, which is the growth engine of the world economy. Indeed China has room for manoeuvre in terms of stimulus policy. Finally, good news about trade negotiations or Brexit is not impossible. Watch this space!