OLZ Market Commentary Q2 2019

Markets reach new highs but look more fragile

Reading time 10 Minuten
  • Political, geopolitical and trade-war risks weigh on global economy and markets
  • FED and ECB are back in easing modus, pushing equity markets to new highs
  • EUR and CHF yields deeper into negative, USD curve remains worryingly inverted

An abused therapy

The repeated central banks’ interventions to quickly fix financial market turbulence and to repress volatility has many parallels to the worldwide increase of antibiotic consumption. The solution of last resort has become a common one. Not only does the prolonged use and addiction have side
effects, but it also results in a loss of effectiveness. In May markets have witnessed a sharp correction, following the USA-China trade war and the escalation in Iran, adding shadows on an already weakening economy. Central banks have intervened promising a renewed and stronger dose of easing. Forget normalization! In the 5th year of negative interest rates and with ballooned balance sheets, ECB and SNB will continue with these extreme measures. The FED is going to cut rates (probably by 0.5%) at the end of July, just 7 months after the last rate hike! Further cuts will follow.

Conditioned behavior with prospects of success

“Never fight central banks” – one of the most well-known rules among investors. With a kind of Pavlovian reaction the market has forgotten all the pains, risks, and uncertainties. Equity indices like S&P 500 or SPI reached new historical highs in June. High yields, emerging market bonds, gold and even bitcoins surged. But the ultimate driver of financial markets are earnings, not the central bank liquidity. And earnings growth has slowed in the last 9 months, while valuations stayed high. Implicitly, the market is very optimistic about accelerating earnings growth over the coming quarters/years. Whether this view is too optimistic is yet to be seen. The USD yield curve spread, however, has remained negative for a relatively long time (3 months-5 years since March), even after the market has discounted the coming FED rate cuts. This indicator is one of the most reliable in signaling an upcoming economic recession. This is just to highlight the uncertainty about the effectiveness of the announced central bank intervention. But frankly, central banks are simply trying to do their job. What is lacking are meaningful political contributions. Over the years, we have witnessed a festival of lost opportunities. Political actors have missed out on the calm periods granted by central banks to implement reforms and long-term structural investments (just look at Brexit, missing EU reforms or large-scale key infrastructure spending).

Investors seem to become more risk-aware

The legitimate doubts about the economy and the financial market running like a perpetuum mobile (as expressed in our Q1 2019 market commentary) are still appropriate. As a matter of fact, investors seem more defensive and more risk-aware oriented than before. This is indirectly reflected in the performance of our risk-based equity funds, which have not suffered the same underperformance as we have experienced during similar market situations in the past. On the contrary, some equity strategies (USA, World Developed, and our flagship Switzerland) have been able to outperform. Our bond funds have performed positively but the lower duration and underweight in the USD yield curve have caused an underperformance.

In the coming years, CHF based investors have to face a challenging environment of even deeper negative interest rates. The consequences for asset allocation decisions are massive. The temptation to generate return by adding complex, costly and
illiquid investments is high. We invite investors to pursue efficiency instead. OLZ risk-optimized bond and equity solutions have proven to be able to add value and stabilize the portfolio in exactly such critical market phases.