Julius Bär: Outlook for the global financial markets in the second half of 2014 Mittwoch, 25. Juni 2014 - 15:49

Broad-based economic recovery continues to favour equities

Subdued inflation supports expansive liquidity stance for the time being as the developed world's main central banks can be expected to continue pursuing expansive monetary policies as long as neutralising the underlying risk of disinflation remains a priority. This is illustrated by the fact that New Zealand, which currently has an inflation rate of 3%, is so far the only G10 country to have begun normalising its interest-rate policies. The United Kingdom is unlikely to follow suit until first-quarter 2015 at the earliest, while in the United States, Julius Baer's investment experts do not expect the first interest-rate hike since the collapse of Lehman Brothers in 2008 to occur any earlier than mid-2015. “Since the Federal Reserve has been unable to deliver on the full-employment mandate bestowed on it by Capitol Hill, it will need to keep its monetary policy far looser than would otherwise be necessary. This will ensure that the official unemployment rate continues to fall, even though labour-force participation remains at a historically low level,” explains Janwillem Acket, Julius Baer’s Chief Economist. The fragility of the growth witnessed in the eurozone so far has increased the risk of disinflation. To counter this, at its last meeting the ECB's Governing Council was thus compelled to institute a substantial range of new measures, comprising not only a discount-rate cut but also the introduction of negative interest rates on deposits placed with it by banks and the targeted provision of credit to the corporate sector, the latter being designed to address the debilitating dearth of lending to companies in the eurozone. The ECB has also indicated that it intends to pursue its low-interest-rate policies for quite some time and has set the duration of its targeted longer-term refinancing operation (TLTRO) at four years. While normalisation of the credit-supply process thus remains an uphill task in Europe, worldwide lending volumes have recently been gaining momentum, somewhat in contrast to the pace of activity in the broader economy as a whole. The amount of excess liquidity available should therefore expand further in future, thus also lending support to financial markets.

Switzerland's economy benefiting more than most from OECD recovery

The ECB’s resolute approach means that it will not be possible for the Swiss National Bank to deviate from its current CHF 1.20 target exchange rate against the EUR in the immediately foreseeable future. “In the present economic climate, this exchange-rate stability against the euro should enable the Swiss economy to grow by 2% in 2014 and even to gain momentum next year,” Janwillem Acket is convinced. This means that Switzerland's export industries are deriving above-average benefit from the current economic upturn, as not only most OECD countries, but also China and other emerging markets in Asia, are now growing at above their long-term trend rates. In aggregate, these markets are now absorbing more than 90% of Swiss exports. On the domestic front, Switzerland's economy is benefiting both from sustained and broad-based growth in consumption and from the continuing robust performance of the construction industry supported by the current historically low levels of interest rates. Companies will continue to find it attractive to do business and invest in Switzerland, since the level of skills offered by the labour force is constantly improving, partly also because immigration by qualified professionals remains still unchecked.

Many major emerging economies' performance currently less than stellar

Meanwhile, the economic performance of numerous major emerging markets is showing weakness, partly due to the gradual blunting of their competitive edge and partly because a number of necessary domestic reforms have yet to be put into effect. High inflation rates, depreciating currencies and imbalances in external trade are all forcing these countries' central banks to raise interest rates, thus constraining economic growth. However, with reviving demand from developed markets now meeting many of these countries' more favourable exchange rates head on, it can only be a question of time before this situation also improves again, probably in the latter course of this year and in 2015. While growth rates in China over the next few years are likely to decelerate to around 6% or 7% as its domestic economy becomes more market-oriented, the sheer size of its economy means that China will remain a significant driver of export growth for many companies in developed and emerging markets alike. For the time being, this expansion will not be sufficiently rapid to drive commodity prices higher, especially since recent innovations mean that traditional suppliers are now competing with new players at a time when the rate of overall demand growth is slowing. This phenomenon is particularly apparent in the energy market.

Financial market cycle now nearing its conclusion

While the economic outlook remains positive and liquidity is still in plentiful supply, after a five-year uptrend, the evidence is mounting that the market cycle for riskier asset classes is now well advanced. Julius Baer's investment experts believe that two investment themes, in particular, have become less attractive in recent quarters. The first is regional and relates to the convergence of peripheral and core markets in the eurozone. As far as bond yields are concerned – particularly the yield premiums on Spanish and Italian government debt – convergence now appears to be largely complete. As Christian Gattiker, Julius Baer's Chief Strategist and Head of Research, sees it: “With risk premiums having now dwindled to only just over 100 basis points on five-year bonds, the market now offers investors only scant recompense for the country-specific default risk they are taking on.” It would thus seem opportune for investors to consider other investment opportunities in Europe. Equities, particularly in the small-cap and real-estate sectors, still have upside potential, since current prices have not yet fully reflected the normalisation in government bond valuations.

The second investment theme is the quality of company balance sheets in the non-financial sector. Balance sheets in this sector have expanded significantly in the last few years. As a proportion of national GDP, the aggregate net debt carried by US non-financial companies has increased to 16%, while their overall balance-sheet totals have risen to 90%. Both are new records. For Christian Gattiker, the message is clear, “Companies are now doing far less for their bondholders and far more for their shareholders than at any time in the last thirty years.” That is a strong argument in favour of redirecting funds away from corporate debt and into direct equity investments.