EDURAN NAVIGATOR

Quarterly Market Review with an Outlook.

Zurich, 31-Mar-2019

“New year – same old regime”. The first quarter was marked by recovery from the Q4 correction. The central banks take one step back with liquidity-injection ready in their hands.

Last Saviour

Very much in sync with the end of the 4th quarter of 2018 (26th December on the S & P 500 and 28th December on the Dax) a countermovement has started, which should last over the next three months. In addition to a technically oversold situation, the announcement of central banks – primarily from the US Fed – to pause the tightening mode and if necessary continue a rather lax monetary policy was decisive. Interest rates might continue to rise, but more leisurely than initially announced and expected. Markets have understood that if the economy falters or the stock markets stumble, the central banks will continue to stand by as fire extinguishers.

cumulative central banks balance sheet of G4-economies

At the beginning of the year, we can also achieve a brief review of the past year: a year ago, many economists and market correspondents expressed themselves very positively in regards to the economy and its growth perspective. There was talk of synchronized global growth and even the return of inflation was announced. The US Federal Reserve raised interest rates over the course of the year and started to cut back its balance sheet. For interest rates a major resistance level has been broken, such as the 10-year US Treasury yield which rose above 3.2% at the beginning of October. Then things changed. With clouded prospects for the coming quarters and simultaniously the tightening of liquidity, markets turned around at the beginning of the crah month October (when the ECB had also begun to reduce its purchase program).

Now we seem to be back in the old channel: the trend is for low interest rates and central banks continuing to support the markets with extra liquidity. It seems to be tricky to exit the monetary policy of stimulus launched in  November 2011 (start of QE-I).

For the first quarter, broken down by regions, Asia gained the most with the Shanghai Composite Index up roughly 25% for the quarter. This is mainly due to the potentially lightening discussions regarding the US-China tariff dispute as well as  stimulus.

US markets also bounced back up significantly, just under 20% for the Dow Jones Index. European markets generally followed at a small discount to the US.

Europe and its export-oriented nations now seem to be more at the mercy of China and are thus sensing changes in available liquidity or adjustment of the economy (including the effects of the customs war).

China with diminishing impact of stimulus on growth

Interest rates

On the interest side, the curve flattened again – latest in with a curve in the negative territory, i.e. an inverse shape. Statistically, such a situation increases the likelihood of a recession and thus of a stock market correction.

Curvature of US-Interest rates

With the somewhat bleak outlook in terms of growth from the 4th quarter of 2018, longer-dated bond yields also declined. The market apparently priced in the likelyhood that central banks policy might be soon back at the point where it all started when launching the monetary stimulus program(s). Even though it is still expected for US rates to raise a little further, but not much more to come in this direction, the tenor is back with relatively low interest rates for the foreseeable future.

comparison of US-Fed balance sheet with Bank of Japan balance sheet.

The US-Fed is in the lead and the other central banks are either continuing to provide liquidity (while the Fed is on hold or tightening) or will join the US-Fed with additional stimulus. This is mainly because nobody wants to have a strong currency in an environment with modest or declining growth. So, despite a flattening yield curve and modest growth we probably still have enough monetary stimulus to support the financial markets. When looking at Japan, there is still room for most central banks to provide liquidity (as well as to monetize debt).

yield of the 10-yr US-treasury

Sectors / Companies

Almost all sectors performed well over the first quarter (telecom sector EuroStoxx600, rated in USD, couldn’t make up its Q4 18 losses). The main beneficiaries were the basic utilities as well as precious metals. The banks have – once more – left a bad impression and are only marginally higher on the bottom line.

Eurostoxx 600-Sektoren im Überblick fürs 1. Quartal 2019

Combined over the last two quarters, defensive stocks – mainly in the utilities sector – posted the highest gains. With its stable, not very cyclical business and usually relatively high dividend payments, these stocks seem to be a popular alternative even to bonds during times of low interest rates. The market thus does not seem to believe in a swift change in the situation of low interest rates and is investing accordingly in order to make up for the lack of income on the interest side.

The price of oil ended its correction also with the quarter change as of year end. In addition to other factors, oil benefit also from a Russia-OPEC deal and might further profit from a weaker US dollar in the medium term (if US-Fed is near the end of the rise in interest rates).

Among single names there was wide spread of performance. The index-level recovery has not included all titles the same. Many stocks are not exactly cheap but meanwhile, after the correction and not being part of the recovery yet, there are individual equities that represent attractive purchases from a valuation perspective as well from technical point of view. For example, Swatch: the Swiss watchmaker has lost about half of its capitalization from its highs and has recently been able to gain only moderately, which is not least due to sales difficulties in China. In our opinion, the title is relatively cheap and in the medium term, a purchase should be worthwhile. There are a number of other titles (BASF, U-Blox, Sulzer, Continental, Hochdorf, etc.) that present an opportunity to buy or that we consider to be interesting. In this sense, the situation has improved for the investor as the recent correction and the recent recovery have left some stocks with significant upside potential.

Technicals / Charts

After a year of correction in 2018, the new year could be a year of volatility and, on a bottom line, a recovery (current V-shape). Technically the long-term upwards trend is still alive, even though there it has taken a hit which eventually might make it to decline further. With the strong rebound during the first quarter we will either complete a V-shape rebound or there will be a profit taking soon and maybe be the last leg of the correction. This scenario would confirm the continuation of the uptrend. Needless to say that if it doesn’t hold the uptrend might be over and the market will make new lows for the coming months (bear market).

DAX (Deutscher Aktienindex) weekly chart with finalized A-B-C correction and ready to move up again.

S&P 500 Index weekly chart also with a version of a completed A-B-C correction and with final move up

Outlook

Although markets have gone through a correction phase since the beginning of 2018 and this could also be the beginning of a bear market, we remain confident and stick to the bull-scenario for the time being. Assuming that central banks will ease the intensity of interest rate hikes and balance sheet tapering going forward, and the economy continues to weaken but remains expansive, bottom-line stock markets may still have some potential left over. The ever-increasing debt burden (US: USD 22 trillion!) should sooner or later lead to a (further) increase in risk premiums, which should also increase longer-dated interest rates. Fundamentally, the situation is not brilliant, but only so much can be bent by central banks for now. Looking at the situation in Japan, you can see what else is possible. Former Fed Chairman Ben Bernanke has already commented prominently on possible scenarios (helicopter money). Equities remain susceptible to fluctuations, but in the long term there are almost no alternative investments in the known environment.

Yours EDURAN AG