The global economy is growing moderately, inflation is low, and the monetary policy is loose. This environment supports many asset classes from bonds to equities. The political uncertainty has been absorbed rather well so far too. Will this situation last?
On Sunday 4 December Italy will be holding a referendum on an amendment to the constitution. This is relevant particularly because in case of a rejection, the political uncertainty would increase.
The arguments supporting a further rise in share prices have become stronger. The important central banks have been sending expansive signals in recent weeks, i.e. signals that support the economy and the markets. The latest measure was the statement made by the president of the European Central Bank (ECB), Mario Draghi, at the ECB press conference on 22 October.
Equities, bonds affected by default risk, commodities, and emerging markets currencies are currently subject to corrections, which, noticeably, have now gone beyond the purview of emerging markets: while the emerging markets equity index declined by almost 6% (Performance-Data Source: Bloomberg, MSCI) last week, the index for developed markets lost 5.3% (Performance-Data Source: Bloomberg, MSCI). The fear that the economic weakening in the emerging markets might come with significant spill-over effects for the industrialised countries has increased. This prompts the question whether a phase of profound corrections is upon us in the risky asset classes. The question alone has caused the risk aversion of investors to rise. The liquidity is temporarily parked in safe havens such as US Treasury bonds, the euro, and the Japanese yen.
Global GDP growth has probably only increased marginally in Q2 after the very weak Q1. Economic activity has thus remained disappointingly weak on a global scale.
Last Sunday, the Greek people decided with a clear majority to follow the proposal of their government. With 61.3%, the No camp rejected the conditions of the expired adjustment program. Thereby, Greece is one step closer to an exit from the Eurozone and the European Union.
Developed equity markets are in the 6th year of a robust upward move. The MSCI Developed World Index rose by almost 18% per annum over the period (Mar 2009-June 2015) in Euro-terms. However, momentum has stalled in recent months. Stepan Mikolasek, new head of equity management of Erste Asset Management, names the main reasons: surprisingly weak US economic growth in the first quarter, concerns about China’s economy, the fear of a Fed rate hike and growing risk related to the Greek situation.
The dynamics of the economy and the markets have declined. Global economic growth is down on a quarter-on-quarter basis, the two most important trends of the past months (appreciation of the US dollar and falling oil price) have come to a halt, inflation is not falling anymore, and the US Fed has put a damper on the expectations of interest hikes. One important exception: the Eurozone has been picking up speed.
The US dollar has appreciated significantly vis-à-vis the euro in the past months. For this trend to continue, at least two developments would have to be in place. Firstly, the US Fed would have to abandon its zero interest rate policy; and secondly, the ECB would have to remain on its path of negative interest rate policy and bond purchases.
We have seen European equities outperform their American peers in the year to date, both in local currency and in euro. Not even the increase of the US dollar relative to the euro of 8% made a difference to that. What is this pro-European optimism based on? After all, the US economy has seen a significantly better development than the Eurozone. The same is true for US companies, which have been recording profit growth, as opposed to Europe, where profits have generally been falling recently. The uncertainties in Greece and Ukraine only add to this scenario.