Global Weekly: Difficulties in Europe

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The US consumer played an important role in supporting the US economy last year. More recently, however, US retail sales disappointed. But with real aggregate income growth remaining strong and consumer confidence high, we believe US consumer spending remains supportive for the economy.

Moreover, progress is being made in other risk areas, like the solved government shutdown and – more importantly – the trade talks with China. All in all, we believe the US should be able to avoid a recession this year. Especially with the Fed pausing further tightening for now. Risks, however, do remain. As a consequence, investors keep pricing in some recession premium in several asset classes. US high yield appears to be the exception to this. In the current environment, this bond segment looks expensive – we therefore remain underweight.

Meanwhile, the economic situation in China might be stabilizing following stimulus and possible advancements in trade talks with the US. Together with the Fed remaining on hold for now, we see sufficient reasons to remain comfortable with our position in emerging market debt.

Europe, however, is facing difficulties. Economic data remains weak, and – in contrast to the US and China – no progress seems to be made in addressing well-known risk factors. So far, the only thing progressing in the Brexit story is time – not plans (could talks currently going on in Brussels provide a solution this time?). As a result, uncertainty remains. With the Italian economy now in recession, the country’s budget could become a problem again. Adding to the uncertainty are the ongoing protests of the yellow vests in France, upcoming elections in several countries as well as European Parliament elections, and the US potentially shifting the focus of its trade negotiations from China towards Europe (US President Trump is threatening to impose tariffs on cars imported from Europe). No wonder ECB Governing Council members Praet and Coeuré recently came up with some dovish comments.

We expect interest rates to remain low for longer. This means duration risk is becoming less unattractive. We maintain our negative view on core government bonds because of their low yields. We remain positive on investment-grade corporates, as we expect this bond segment to perform well against a backdrop of low growth – no recession – and low inflation. Increasing risks to growth, however, have led us to add some quality to the portfolios by adding covered bonds. We consider spread levels in this bond segment to be relatively attractive.

Corporate governance issues hit financial stocks

Equity markets moved slightly up this week. In terms of performance, most sectors moved in tandem. The health care sector – lagging for no specific reason – was an exception; so was the materials sector, which outperformed due to higher metal prices.

Within the communication services sector, we see tepid outlooks for the telecommunication segment. Telecom players are getting a bit more cautious in their guidance. They see more fierce competition and also have to spend billions of dollars on next-generation mobile networks.

This week, we witnessed how corporate governance issues in the financial sector can influence share prices. A Paris court ordered UBS to pay more than EUR 4.5 billion, after finding the bank guilty of enabling clients to hide their assets from tax authorities. This amount includes a fine of EUR 3.7 billion and an EUR 800 million compensation for missed tax payments owed to the French government. UBS said it would appeal against the ruling. Shares in UBS fell approximately 5% following the verdict.

On Wednesday, following a report by a Swedish broadcaster about dubious transactions between Swedbank and Danske Bank, Swedbank said it had identified suspicious transactions and informed the police about it. Danske Bank is involved in a money laundering scandal via its Estonian branch and under criminal investigation by the US Justice Department. Because of the Danske Bank scandal, financial regulators in Denmark and Estonia are under investigation by the European Banking Authority.

Thursday, the US Securities and Exchange Commission announced it will also investigate Danske Bank. Shares of Swedbank plunged about 14% after the news about the connection with Danske Bank came out.

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