Global Weekly - Not out of the woods yet

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After the sell-off of last week, markets stabilised a bit in the last days. Especially the US earnings season helped investors to regain confidence. Morgan Stanley, Goldman Sachs and JPMorgan were able to beat estimates and Netflix is back on track with strong subscriber growth.

After the sell-off of last week, markets stabilised a bit in the last days. Especially the US earnings season helped investors to regain confidence. Morgan Stanley, Goldman Sachs and JPMorgan were able to beat estimates and Netflix is back on track with strong subscriber growth.

The earnings season in Europe, however, gave a slightly less enthusiastic picture. The numbers from Fresenius Medical Care on Wednesday morning, for example, shocked investors. They had anticipated the company would do better in US health care, but obviously, the opposite was true. As a result, the company was down by roughly 16%.

At some point, rising interest rates are negative for the stock markets, as borrowing costs go up and discount factors in valuation models increase. So the question is: at what level of 10-year Treasury yields will investors rotate from equities into bonds? According to the latest Global Fund Manager Survey conducted by the Bank of America, that is 3.7%. If the current dividend yield of the S&P 500 is 1.8% and the share-buy-back yield is 2.2% (together 4%), then it indeed makes sense to assume that 3.7% is a trigger to switch into less risky assets.

As long as inflation remains contained and the fiscal stimulus will fade in 2019, there is no reason for the US Federal Reserve (Fed) to increase rates beyond 3%. We also think that at some point the US and China will come to a good solution to end the trade war, maybe just after the US mid-term elections on 6 November or at the beginning of 2019. This should also give a boost to the stock markets. For the time being, we are slightly overweight equities with a large bias towards North Amerika. On the sector side, we are overweight energy. The latest stock market action leads us to believe we are in a correction phase which may not be over yet.

Fed to stay on course

The tone of the Fed minutes, released on Wednesday, proved to be quite firm. Indeed, despite the challenges of US President Donald Trump, the US Federal Reserve (Fed) thinks that the risks weighing on inflation are now on the rise and wants to continue gradually raising its rates.

The market had been expecting this outcome with 10-year US Treasury yields spiking above 3.20%, the highest level in six years, before recovering again later. Next week, the Italian budget proposal is up for evaluation at the European Commission. The expected outcome is a well-tempered set of measures, featuring both strong discipline to mitigate the growing deficit and to stabilise debt, as well as short-term stimulus to kick-start the stagnated Italian economy. The market has already priced in a possible credit rating downgrade of 10-year Italian government bonds (BTP).

On the high yield side, investors divested more than USD 5 billion from US high yield funds, motivated by the interest rates increase in the US. It constitutes the largest outflow since February 2018, that was largely related to a spike in volatility. This time, it reflects a more pronounced risk-off mood as 10 year US Treasury rates have reached their highest level, raising concerns over refinancing huge amounts of debt.

In the coming days, the market is awaiting the Italian debt downgrade from BBB and we believe Italy will remain investment grade. Regarding the political crisis between the US and Saudi Arabia, it might bring some volatility to the energy sector, but the market will quickly move on. Finally, credit yields are following an upward trend with some volatility on the way. We have to get used to that and adjust our strategy accordingly.

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