A more balanced positioning

Investment Policy, July 2020

A more balanced positioning

Many investors are asking themselves why markets are going up when unemployment is high. The short answer is that equity markets look ahead. Unemployment is a late indicator of the economic cycle, whereas early indicators are already pointing to an improvement. Furthermore, the economic stimulus injected by central banks has recently been ramped up dramatically to new levels. In particular, the European Central Bank (ECB) has expanded its asset purchase programme  from EUR 750 bn to EUR 1,350 bn. This is boosting both equities and the Eurozone’s economy. 

It was already apparent following the economic slumps of 2002/03 and 2008/09 that equity markets were embarking on a recovery much earlier than unemployment or industrial production. The latter two phenomena tend to be trailing, i.e. late-cycle indicators. Moreover, this time the recession is the direct consequence of the decision made by governments to impose “lockdowns”. This means that the economic recovery can begin more swiftly than after previous recessions – as long as the pandemic does not flare up again dramatically. In addition, this recovery will be supported by a degree of economic stimulus that has no historical precedent. The governments of the world’s leading economic nations have injected stimulus of no less than 3-13% of gross domestic product (GDP) into the global economy. On top of this we should also factor in the enormous economic stimulus provided by the key central banks, amounting to a further 5-15% of GDP – depending on the country or region. The easing of lockdowns, i.e. the reopening of shops and businesses and the resumption of normalized economic activity, will lead to a further improvement of the global economy, as long as there is no dramatic acceleration of the virus outbreak. In particular, this positive trend could be strengthened if consumers and companies regain some of their confidence and start investing and spending more.

Whereas it had previously been the US central bank (Fed) that had led the way in flooding the markets with liquidity through “quantitative easing” (QE), it is now the ECB that has surprised the financial markets by unleashing even larger stimulus packages. Thanks to the latest development – the ECB expanding its Pandemic Emergency Purchase Programme (PEPP) from EUR 750 bn to an enormous EUR 1,350 bn – the economy and above all the stock markets of the Eurozone should now have more “pep” (i.e. momentum) going forward. It is worth pointing out that the European economy is already improving, as can be seen from various leading indicators. In addition, the valuation of Eurozone equities has now become interesting when compared to global equities (MSCI World). When viewed on the basis of their price/book value (P/BV) ratio, Eurozone equities are valued at an eye-catching 35% discount to their global counterparts. But even on the basis of their price/earnings (P/E) ratio, Eurozone equities are still trading at an appealing discount of 15% or so.

The valuation of Eurozone is compared to the price/book value ratio 35% lower.

Gérard Piasko, Chief Investment Officer

Just like the Fed, the ECB is supporting the bond markets generally, and the corporate bond segment in particular, with greater economic stimulus in the form of additional liquidity injections. In a historical comparison, it is clear that corporate bonds continue to offer interesting additional returns compared to government bonds. In addition, in contrast to earlier phases of QE, the asset purchase programmes of the central banks are now even extending to corporate bonds with lower credit ratings. The market’s attitude in the past was always “Don’t fight the Fed”, i.e. focus primarily on those investments that the US central bank is supporting. It would therefore not surprise us if corporate bonds – and probably also the high-yield segment – were to outperform government bonds in the medium term, particularly as the latter barely generate any return at all nowadays. That said, although high-yield bonds continue to offer an appealing yield of some 5-6%, this inevitably means they are traditionally more volatile than other bonds. Government bonds therefore exercise a hedging function with respect to equity risks. 

On the currency front too, we prefer a more balanced positioning. Our decision last month to take profits from our overweight position in the US dollar has proved correct, as the US dollar has depreciated sharply, particularly against the euro. The currency of the Eurozone is more in demand right now for three reasons: The first of these is the greater-than-expected economic stimulus injected by the ECB, which surprised markets by ramping up its QE programme from EUR 750 bn to EUR 1,350 bn. Secondly, as a result of the massive rate cuts implemented by the Fed, the yield differential is now much less in favour of USD than it was. Thirdly, on the basis of inflation-adjusted purchasing power parity, the euro became historically cheap during the coronavirus crisis, whereas the US dollar became expensive. The Swiss franc also remains fairly expensive when viewed in historical terms, whereas sterling (GBP) is dependent on new developments in the Brexit negotiations, which could trigger bouts of higher volatility at any time.

The stabilization is also evident in the world of commodities. Industrial metals have recovered quickly with the improving economy. The same is also true of crude oil, which has once again lived up to its reputation of being subject to sharp fluctuations. The oil price has also gained support from the extension of the agreement between Russia and the Organization of Petroleum Exporting Countries (OPEC), which will now see total oil production cut by 9.7 million barrels a day (instead of the expected 7.7 million a day). Whether or not the oil price continues to rise will largely depend on the development of global oil demand. Where gold is concerned, two factors come to the fore right now: On the one hand, the price of gold continues to derive support from ongoing geopolitical uncertainties. On the other, however, improving economic data could lead to a certain amount of profit-taking following the impressive surge of recent months. This selling pressure could be prompted by a renewed rise in low long-term yields as the economy recovers, as well as by the fact that the demand for gold may have been exaggerated somewhat recently, particularly in the US. Over the last three months, the volume of physical gold imported into the US has exceeded the total import volume recorded over the last eight years. The volume of investment in precious metal ETFs has also risen dramatically in a short space of time, and here too profit-taking may impact prices. It could therefore make sense to take profits through a slight reduction in the high portfolio weighting of gold.  

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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This publication is intended for information and marketing purposes only, and is not geared to the conclusion of a contract. It only contains the market and investment commentaries of Maerki Baumann & Co. AG and an assessment of selected financial instruments. Consequently, this publication does not constitute investment advice or a specific individual investment recommendation, and is not an offer for the purchase or sale of investment instruments. Maerki Baumann & Co. AG does not provide legal or tax advice. In addition, Maerki Baumann & Co. AG accepts no liability whatsoever for the content of this document; in particular, it does not accept any liability for losses of any kind, whether direct, indirect or incidental, which may be incurred as a result of using the information contained in this document and/or arising from the risks inherent in the financial markets.

Editorial deadline: 20 July 2020

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