Investors’ Outlook September 2019

Global economy may find its stride in the second half

This year’s New York triathlon was cancelled due to a heatwave. The global economy is also battling with exhaustion: the energy drinks provided by central banks will only have their desired effect toward the latter half of 2019.

The three main economies competing in the global “triathlon” are not performing so well: the American competitor, normally so successful, is suffering from heatstroke. China, an equally ambitious rival, is increasingly falling behind. Germany, usually a promising contender, is also flagging. On top of that, all the competitors seem to be in an argumentative mood.

Liquidity injections make no difference

Since they are the key organizers of the triathlon, central banks make every effort to ensure the competition runs smoothly. There has been no further mention since January 2019 of the interest-rate hikes and liquidity scarcity announced back in 2018. The US Federal Reserve has even cut interest rates recently, and the European Central Bank (ECB) wants to relax its monetary policy even further. Although plenty of energy drinks are on offer to boost the competitors’ performance, they are not having any effect. Economic growth is particularly sluggish in Europe and China.

Many observers are wondering whether central banks are losing control. Several answers are possible. On the one hand, supportive measures are welcome, as healthy economic growth requires low interest rates and adequate liquidity. On the other hand, the renewed liquidity injections are increasingly losing their effect, as the economic principle of diminishing marginal returns also applies to money. In our opinion, however, this return is still well above zero. The sharp decline in bond yields suggests that the economic outlook has deteriorated significantly. In this respect, the much more generous monetary policy recently pursued by global central banks is only logical. As a result, corporate financing costs are falling, although the positive effect will only materialize with some delay (see chart). Our analysis shows that economies should only be able to reap the fruits of their revised monetary policy in the second half of 2019.

Can other sponsors step in to help?

Could a different organizing committee come to the rescue? After all, governments can resort to other instruments such as tax incentives or investment programs to stimulate economic growth. Germany is repeatedly mentioned in this context. It could finance the desperately needed modernization of its infrastructure fairly comfortably. But Berlin continues to resist such plans and for the time being wants to keep the public budget balanced. Italy is also thinking aloud about support measures for the economy, but cannot afford them due to the crippling level of public debt. Government intervention is therefore very unlikely. However, both the US and China could surprise everyone by launching much more ambitious economic stimulus packages than previously expected.

More obstacles on the course

When the top runners stumble over each other, sensible measures taken by the competition organizers are of little use. The smoldering trade war between the USA and China has since escalated again: at the beginning of August, President Donald Trump decided to impose an import tariff of 15% on 300 billion US dollars’ worth of Chinese imports not previously taxed. But he only imposed the tax immediately on half the goods, probably out of concern about the reaction of stock markets. He has scheduled the taxation of the other half for the end of the year. But the fear of a further escalation in the dispute weighs heavily on market participants.

Situation should not be overdramatized

No matter how serious the trade conflict between the world’s two superpowers, it is important to keep things in perspective. In the cold light of day, both the US and China are able to cope with the new tariffs. We anticipate a negative impact on economic growth of around -0.1% for the US and -0.2% for China. Contrary to popular opinion, the Chinese economy is not very dependent on the US Although 20 % of Chinese exports go to the US, America only accounts for some 5% of China’s industrial production. Around 70% of Chinese production capacity is destined for the domestic market, and 25% for other countries. This is why we think the current fears of recession are overdone. For the outlook to improve, however, the major central banks must not only talk, but also act. We expect them to do so, even though the chair of the US Federal Reserve Jerome Powell, for example, is doing everything in his power to play down expectations about a further loosening of monetary policy.

We are still comfortable with risk

We still have a moderate risk appetite. We retain our overweighting since the summer in equities, and our long-standing overweighting in corporate bonds. However, we have adopted a defensive stance for equities. Within this asset class we have an overweight position in Switzerland and in industrialized countries in general, but an underweight position in emerging markets. We still view Swiss real estate as a safe investment, especially for Swiss franc portfolios compared with bonds denominated in Swiss francs. As a stabilizer in portfolios, gold should generally do well if nominal interest rates fall or uncertainty increases.