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Since early August, renewed trade tensions between the US and China have largely caused a mild retreat of the S&P 500 from its all-time highs, while on the other hand, the Eurostoxx Banks Index has touched a 30-year low.
Source: Factset, 31/08/1991-20/08/2019
These trade escalations struck fear in the market that a US recession was imminent as the 2-year /10-year yield curve inverted while another fear indicator, gold bullion closed above USD1500 an ounce, still below its peak of USD1920 (Sept 2011). Given the length of the current bull market and recurring uncertainty around trade (and Trump-induced rapidly changing sentiment), these worries might seem appropriate. We would advocate to maintain perspective and default to fundamentals rather than fear and emotion.
First of all, the predictive power of the yield curve inversion is at best questionable in a historic perspective and its potential warning signal for a recession is currently blurred by QE, demographics (and related liability-driven investments) and negative rates in all major DM markets, except the US. Australia, for instance, has not endured a recession since 1992, although it had often faced an inverted yield curve for longer periods.
Incoming macro data related to China and US – especially non-manufacturing – indicate manageable effects from the trade tensions. The US consumer remains in good shape while fiscal easing in China has had a counterbalancing effect. With oil prices range bound and mortgage rates at low levels, the US consumer should continue to support the US economy. Noteworthy, in Q2 US consumer spending rose 2.6% while it was the ninth consecutive quarter where consumer income has outgrown spending, so there is good buffer for more spending. Germany, due to its higher exposure to capex heavy end markets, is more impacted by the trade issues and is at the brink of a recession.
Looking specifically at Europe, where political deadlocks continue to hamper more (foreign) money flowing into equity markets, it is however worth pointing out the market-friendly appointments at the EC and ECB, Macron’s labor reforms, Germany finally contemplating fiscal stimulus and last but not least, the ECB’s September meeting where more QE will be announced. At the same time, valuations (more on that in the charts below) and the yield gap are a strong support for equities.
Second quarterly earnings results have been relatively benign, and although reflective of a slower growth environment, they came in above (lowered) expectations, with more positive surprises in the US vs Europe. Multiples have significantly expanded since the beginning of the year, from a low base after the 4Q turmoil, but remain acceptable especially if we would (finally) accept the view that interest rates will remain low for a considerable time. Despite the higher apparent multiples in the US vs EU, we need to make the distinction between sector composition and be critical about where to put money for the longer term, e.g. in European banks or the Technology sector, which has a much higher weighting in the US. Most if not all of the valuation difference between the US and EU stock markets is due to sector composition.
Despite the ever increasing list of market related concerns, we would refrain from reactive (panic) selling and stay invested in the markets, using periods of volatility to add to long term convictions (see picture below). We continue to favour investing in quality companies that are able to grow their top line through the cycle, with competitive advantages, relatively low leverage, less prone to disruptive forces and ideally being able to capitalize on the so-called sustainable development goals (SDGs). Barring a further escalation in the trade conflict, with a truce between US and China at some point in time, our base case is a slow growth environment underpinned by the consumer and services sectors.