di Christophe Bernard, Chief Strategist di Vontobel
It is quite clear that the initiatives taken by the Bank of Japan (negative deposit rates) and the European Central Bank (“pre-announcement” of further monetary easing in March) have failed to calm market fears. On the contrary, the protracted weakness in commodity-related sectors and emerging markets is fuelling fears that the slowdown in manufacturing is spreading to the rest of the economy. The recently released January ISM non-manufacturing index came in weaker-thanexpected level of 53.5 (versus an upwardly revised level 55.8 in December). US nonfarm payrolls of 151,000 new jobs also came in below expectations, even though details related to wage growth were quite constructive. As market participants are pricing in a higher probability of a recessionary outcome, bank shares and bank debt have sold off heavily, with stress reaching levels last seen during the euro-zone crisis in 2011 and 2012.
The core issues at stake are as follows:
China The transition towards an economy based on consumption and services is proving tougher than expected, as overcapacities in basic industries take their toll on corporate profitability and weigh on global prices. At this juncture we guess that this is adequately reflected in the local equity markets, with the Shanghai Composite index having lost close to 50 percent of its value from its summer 2015 peak.
Oil Leveraged producers are fighting for survival at current prices, but the removal of capacity is a pre-condition for energy prices to recover. While it is difficult to call the bottom, we stick to our expectations of oil prices moving higher toward 40-50 US dollars during the second half of the year.
Emerging markets Emerging markets have been suffering under the twin impact from the China economic slowdown and the commodity slump. Local currencies have depreciated and for the first time in many years appear undervalued versus developed-market currencies. However, emerging-market assets should stabilise in tandem with commodity prices, in our opinion.
Bank creditworthiness Bank stocks and bonds have been hammered on fears of credit quality. We consider current fears as flatly overdone, with the exception of a few banks whose business model leave them overexposed to market risks. In the US, banks have vastly improved their capital position since the financial crisis and their exposure to the energy sector is a fraction of their exposure to the consumer, who is benefiting from employment gains, a pick-up in wage growth, much lower gasoline prices and declining mortgage rates. In Europe, capital buffers have improved too, although some countries still grapple with high levels of non-performing loans. Furthermore, political uncertainties in Spain and Portugal do not help sentiment. Nevertheless, banks have unencumbered access to various liquidity programmes from the European Central Bank, if need be (also see our Market update on US and Swiss banks, which will be released shortly).
How to position portfolios? While we broadly identified the issues surrounding commodity and emerging markets in a timely manner, we did not anticipate stress to spread into other segments, which triggered recent losses. At current market levels, we believe investors are discounting a scenario which is excessively pessimistic. This leaves a number of assets with potential significant upside once fundamentals regain traction. We therefore retain our moderate overweight stance towards equity markets and high-yield bonds. However, there is no immediate path towards a resolution and we expect volatility to remain elevated in the period ahead. At the same time, we shall closely monitor any evidence of systemic risk, which could affect the real economy. All in all, we think that investors should keep a “steady hand”.