Central Banks believe being now out of ammunition
OUR MACROECONOMIC ANALYSIS
The three largest developed economy Central Banks met again in April. The Bank of Japan took the markets by surprise in ultimately declining to take new easing measures. This could very well be a sign that Central Banks believe they are now out of ammunition. Governments must now seriously pick up the pace of structural reforms to make long-term growth last. It happens that growth generally fell short of expectations in the first quarter, except in Europe and China. The current slowdown includes a strong structural component (i.e., demographic changes and a marked slowdown in productivity gains). The consensus nonetheless forecasts a macroeconomic upturn in the second half, which will be welcome in the current environment. This rebound has already been abundantly priced in to commodities.
On the microeconomic front, initial first quarter 2016 earnings reports provided some relief, with top-line figures on average coming in above forecasts – which analysts had downgraded sharply – and bottom-line ones even more so. Even so, earnings were still down by 9% (in the case of the S&P 500) and by 10.5% (for the EuroStoxx) vs. the first quarter of 2015. Much the same trend was seen in emerging markets, with earnings remaining lacklustre.
Cutting earnings guidance in order to beat the consensus has now become the rule in the US and is beginning to spread to Europe. But this doesn't fool anybody, and guidance is examined even more closely.
EQUITIES
The MSCI World gained 1% (in euros) in April, bringing its year-to-date performance to -3.4%. Emerging markets were up +0.6%, which boosted their YTD performance to +6.3%. Among developed economies and in local-currency terms, the Eurostoxx posted the largest gain (+1.5%), followed by the SP500 (+0.4%), while the Topix remained mired in a slump, with a loss of -0.5%.
As in March, commodities (up sharply on the month) and exchange rates were a big factor in market gains. A weak dollar and flat yuan provided some relief, while a stronger yen squeezed markets in Japan and worldwide.
FIXED INCOME
Ten-year German and US sovereign yields traded in almost perfect tandem within a horizontal canal about 20bp wide, as they tracked macroeconomic data and central bank announcements. In April, the highest-yielding assets – i.e., high-yield corporate bonds and emerging sovereign bonds – got the biggest boost from the current environment.
CURRENCIES & COMMODITIES
The USD gave up further ground in April, in particular vs. developed and Latin American currencies. The dollar lost almost 1% to the euro. The Fed was more flexible than expected in its forward guidance; macro data was more favourable in Europe; and Europe continues to run a massive current accounts surplus. We might add that the ongoing commodities rally has also fed the dollar’s decline.
Commodities as a whole gained 4.1% in April, driven by oil (+15.5%), as well as metals (+7.9%) in general and iron ore (+20.5%) in particular. Strong March Chinese trade figures — released in mid-April — had restarted speculation regarding demand, and combined trading volumes on the commodities markets of Dalian, Zhengzhou and Shanghai reportedly more than tripled between their February average and their late-April peak.
OUTLOOK
Our concerns for the coming weeks are once again focused on macroeconomic themes. To sum up, after disappointing Q1 growth – with the notable exception of the euro zone – and more downgraded forecasts, expectations of a Q2 upturn must be met. But, taking the major economies one by one, the possibility of negative surprises cannot be ruled out. The US economy has been heavily commented on. Neither the Q1 GDP components, nor the April survey data are any cause for optimism, especially as they come against a backdrop of declining productivity. The Fed has fallen into line with this state of affairs, judging by the especially accommodating tone of its chairman. Inflation must not accelerate too much, i.e., beyond the expected basis effects. Data from Japan are actually a cause for real pessimism, given that, on top of the “surprise” status quo at the Bank of Japan’s latest monetary policy meeting, Abenomics could well be coming off the rails. The government is blaming Japanese companies for under-investing and failing to raise wages more. Those companies retort that the growth outlook is not good enough. The standoff could last for some time to come. We would merely point out that the Japanese corporate sector now holds cash that is equivalent to 50% of Japan’s GDP. China, in contrast, had some good surprises in store, thanks to a massive, debt-finance boost to growth. Let’s try to remember that the authorities are managing a slowdown trajectory. Based on long-term objectives, they may already have overreacted. In other words, lending could slow and growth with it.
POSITIONING OF PORTFOLIOS
In this environment, we have scaled back risk considerably in our portfolios, particularly in equities, whose valuations must be revisited in light of downgraded earnings forecasts. We are more neutral on corporate bonds (high yield and Investment grade), particularly in Europe, encouraged by a more favourable economic picture and a pro-active central bank. We also reduced our exposure to Japanese equities while raising our exposure to emerging market debt, as we expect growth to be more domestic than global in the coming semesters.
In the portfolios, we stepped up our long euro bias.
Authors
Nicolas Chaput – Global CEO & Co-CIO Oddo Meriten AM
Laurent Denize – Global Co-CIO Oddo Meriten AM