Investment View Q2 2016
The less hawkish stance on interest rates by the Federal Reserve Bank (Fed) and a comeback of the Oil price ignited a strong rebound of global stock markets, which erased the worst start to a year ever. Nonetheless, we still see several risks, leading us to position towards mainly capital protection strategies and neutral currency exposures.
A first risk is the recent disappointing US economic data and inflation running at four year highs. The Federal Reserve Bank has put itself in a difficult position, making it vulnerable to a policy mistake. If the FED raises interest rates too soon it risks a higher US dollar, pressure on emerging markets and deflating asset prices. If it keeps delaying higher rates it basically continues to inflate asset prices, provoke even higher debt levels and create serious credibility issues with global Central Banks.
A second risk is that the recent Chinese stabilization could be more short-lived than expected. Chinese policymakers have to maneuver through supporting growth while at the same time supporting reform and rebalancing the Chinese economy. The Chinese stimulus may also prove to be less effective in improving consumer demand.
One contributor to the stabilization in China and Emerging markets has been the weaker US dollar and receding expectations of a US rate hike. But these may well be temporary. Financial markets probably underprice the risk of Fed rate hikes over the next year or two.
Political risks in Europe are high and rising. The UK’s upcoming EU referendum (June 23) remains a key uncertainty for the coming months and we believe a “Brexit”, if it happens, would be a major negative in economic and political terms for the UK and EU as a whole. We still think the probability of the UK leaving the EU is low, but one cannot ignore it in risk management. There are other sources of political uncertainty in Europe, with new elections due in Spain, high support for non-mainstream parties in countries including Austria, France, Italy, the Netherlands, Sweden, Denman, Hungary, Poland and Slovakia, and rising non-mainstream support even in Germany.
Another more immediate risk to equity markets are high valuations in the US and Europe in combination with the current low growth environment. These valuations cannot be maintained unless the global economy delivers higher growth and corporate profits start to rise again, which still has to be seen.
We expect a volatile summer as the world cannot cope with a higher US dollar and rates yet. Easy monetary policies have been an important driver for asset prices for the longest period ever. Higher valuations, three years of unproductive corporate behavior, limits to further easing and excessive borrowing from the future suggest that the market may has overstretched.