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Market Commentary Q3 2019

A positive quarter thanks to expansive monetary policy

Reading time 10 minutes
  • Global economy outlook remains clouded, central banks push rates lower
  • Equity market close to historical high, discounting optimistic earnings growth
  • Negative interest rates are definitely here to stay, risk optimization pays off


A promise you can count on

With the reliability that distinguishes them, central banks have kept the “promise” and facts have followed: FED, ECB and 10 other central banks have reduced their reference rate over the quarter. Yield curves have come under massive pressure, following a mix of rising flight to quality (due to political uncertainty and weakening economic outlook) and the reactivation of quantitative easing by the ECB. As a consequence the amount of bonds with a negative yield has risen to about USD 16 trillion, a new record. Looking at the forward interest rate for the coming 10 years both the EUR and the CHF yield curve will remain in negative territory. The effective rate dynamics can clearly deviate from the implied forward rate, but frankly it is hard to imagine rates back into positive territory in the next couple of years given the worsening economic outlook. This is particularly the case in Europe, with Germany’s manufacturing industry in strong contraction. Not to mention the foggy situation on the other side of the Channel. Make Britain great again by going solo sounds like an illusion, which is unfolding in a farce. Only time will tell if it will end up in a tragedy, as many observers anticipate. What is sure, however, is that any damage to the UK economy will affect continental Europe as well.

Investors are happy but remain worried

The main actors keep on performing their roles: politics is busy with itself, unable to address structural problems; central banks keep on acting (very) preemptively, with unorthodox measures, successfully keeping the market afloat.  In the previous quarter commentary we claimed that an extended use (abuse) of such measures will not have the same marginal effect over time. As a matter of fact, the reaction of the risky asset has been less sanguine compared to similar central bank action in the past. Equities remain close to a historical high level. According to Bloomberg, current valuations imply an earnings acceleration with a growth rate of about 10% for the coming years. That sounds quite optimistic considering the fact that the outlook is clouded by a slowing economic growth, trade war and geopolitical risk.

Over the last quarter equity and bonds have had similar low single-digit positive performances. The year to date’s positive performance has increased further and more than compensated for the 2018 negative return. Despite this, investors are feeling increasingly uncomfortable and are more risk-aware. This is reflected by market risk indicators rising compared to the past three years. In such a context our risk based strategies have performed in a satisfactory way, confirming in full our as well as our clients’ expectations. We keep our promise as well.

Between negative yield and a hard place

A significant contribution to the positive portfolios return YTD comes from the yield reduction, which means that one has to expect less contribution from fixed income in the future. This increases the complexity for investment decision makers: negative interest rate, low interest rate spread, stretched real estate and equity valuation. To achieve a positive expected return, the risk profile of the investments must be substantially higher than in the past. It follows that proper diversification and risk management should be the main focus of every investment strategy. Actually we are of the opinion that this should always be the main focus and not only in exceptional times like the current one. In any case OLZ clients can rely on the necessary expertise to navigate through these troubled waters.

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