We have stock indices approaching record levels, oil prices stabilizing, summer worries like Brexit, China and Italy off the table, and now, after the tremendous generosity of the central banks, governments may even start tapping their fiscal cornucopia. Shouldn’t this be cause for euphoria, particularly when we know that it’s skepticism fueling this rally and not euphoria?
We recommend taking a sober approach in this environment, and we explain why in our current CIO View. Economic growth remains modest, especially in the developed markets , which is the reason many central banks are still hoping for government support. Governments, on the other hand, appear to be having a hard time with reforms and may much rather hand out money. This comes on top of an uncertain political environment, even in developed markets. Brexit is not yet a done deal and is slowly but surely becoming a headache for governments and businesses alike. Italy is on the verge of a referendum that, if rejected, would almost certainly exacerbate the fragile state of the country and especially the banking sector. In addition, the United States has two presidential candidates that share one thing in common: how equally disliked they are by an unusual large segment of the population. Those who think political stock markets are short-lived need only take a look at the British pound or, better yet, the Mexican peso, which is almost acting as a barometer for the U.S. elections. This is just one example of how dependent the emerging markets (EM) still are on developed markets and important to keep in mind in the excitement around the EM’s current stabilization. Be it the oil price, the U.S. dollar’s strength or China’s waning thirst for imports – several factors could bring the EM’s summer fairy tale to an end.
However, for the time being, like most other asset classes, EMs can still rely on the generosity of the central banks. There are still little signs or even much of a chance loose monetary policy will end soon. The U.S. Federal Reserve is increasingly emphasizing that its reluctance to raise interest rates stems more from structural concerns than worries about cyclical headwinds.
All this doesn’t sound like much cause for euphoria. Admittedly, we’ve only mentioned the risks. But we’ve done so because it’s dangerous to underestimate the pitfalls simply because they are no longer making headlines. We remain cautiously optimistic since the situation is not all that bad. In fact, most economies are progressing in a tepid environment. As it turns out, that’s the best course of action for many asset classes. We hope markets stay dull because, even then, it presents a challenge to achieve solid returns.
Stefan Kreuzkamp, Chief Investment Officer