Running with the euro equity bulls

Running with the euro equity bulls

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Expectations are high that the European Central Bank will signal a renewed round of stimulus on Thursday, with some thinking it could actually arrive sooner than September.

Truth be told, markets have already rallied hard ahead of the long-anticipated ECB policy pivot, as has Wall Street with the Federal Reserve set to cut its overnight rate for the first time since late 2008. But you can’t keep the bulls corralled for long when the big two central banks are finally set to join the party.

On Tuesday the region-wide Stoxx Europe 600 index was within a whisker of hitting a new high for the year (up 16 per cent), while France’s blue-chip CAC 40 index set a fresh intraday peak for 2019. A cheaper euro also helps as the single currency loiters inside $1.12 versus the US dollar, near its weakest level in more than two years. 

Here’s BlackRock elbowing its way through the Pamplona throng:

“The easing we expect the ECB to deliver is not yet fully reflected in markets” which means the asset manager has upgraded European government bonds to overweight as it expects “peripherals, or government bonds of mostly southern-tier countries, to benefit most from the fresh stimulus”.

It’s also joining the “lower for longer” interest-rate crowd (highlighted in Monday’s MF) by looking to own high-yield corporate credit, while BlackRock is no longer underweight eurozone equities bar a couple of caveats:

“Equity risk premia (the expected return advantage of holding equities over government bonds) in Europe are now similar to those of riskier emerging markets. We prefer the quality factor and defensive sectors that feature high profitability, stable earnings and low indebtedness, such as pharmaceuticals. We like companies with sustainable and relatively high dividend yields.”

So which eurozone equities should be avoided? 

“We generally dislike the consumer discretionary sector due to its vulnerability to trade conflicts, and avoid banks given negative rates.”

What excites BlackRock and other investors at the moment is how financial conditions in the eurozone are improving, a situation that is expected to continue as the ECB adds stimulus via asset purchases in the coming months. This chart from BlackRock shows the rate of gross domestic product growth implied by their financial conditions indicator (FCI) for the eurozone.

BlackRock financial conditions indicator for eurozone, 2010-19

But as the chart above shows, conditions have already improved considerably. Casting back to 2015, once quantitative easing began, there was quite a rise in German and eurozone bond yields. It seems that once the easy money has been made, markets tend to reverse course, with early buyers heading for the exit.

Of course, there’s the nagging question as to whether ECB easing will really move the needle at all. Will its policies generate higher inflation expectations and economic momentum? 

Marc Ostwald at ADM ISI is pretty blunt about the chances of success:

“Precisely what the economic benefit of a series of ‘salami’-style rate cuts, or even more QE would be appears to be the talking point that markets are totally oblivious to.”

There may be other ways to jolt the market. Here’s BlackRock’s Rick Rieder via an FT Insight column with a solution for the ECB: just buy equities. 

That should strike many as a step too far. Rather than relying on monetary policy, the eurozone surely requires a shot of fiscal ammunition. As Marc from ADM notes, expect to hear another plea on that front from Mario Draghi during his ECB press conference on Thursday: 

“One can certainly expect Draghi to emphasise that the onus cannot fall on the ECB alone, and that governments need to implement much more in the way of structural reforms, and where fiscally viable, increase spending (yes, that means you, Germany . . . and not you, Italy). But that refrain has been peddled by Draghi, Trichet and Duisenberg for 20 years, and the results of government inaction are all too evident.”

As more central banks look to up the ante in the global rate-cutting stakes, the obvious worry is how much longer can asset prices keep surfing the liquidity wave.

The latest Global Economics View via Citi conveys this health warning for investors: 

“Amid accommodative financial conditions, however, we stress that additional monetary policy easing at this stage of the global economic cycle could lead to frothiness in financial markets, lower (for much longer) rates, as well as currency wars.”

And here’s another potential outcome that should temper the bullish pack:

“Moreover, we have stressed that ‘looser monetary policy amid robust growth, low inflation and high stock prices’ could indeed give the US administration additional room for a more aggressive trade policy stance; which would prolong the uncertainty currently clouding the global economy.”

Quick Hits — What’s on the markets radar

A calm pound before the storm — Now that Boris Johnson will be making 10 Downing Street his home, sterling sits below $1.25, pretty much near the bottom of the $1.20 to $1.44 range for the currency since the UK voted to leave the EU. On the surface, plenty of bad news is priced into the pound, but the new prime minister has 100 days to seal a deal that his predecessor could not achieve in three years.

David Page at Axa IM says:

“Our conviction remains that the Brexit saga will persist beyond 31 October, seeing a greater possibility that Johnson will seek more time to pursue ‘fruitful’ negotiations with the EU — or Parliament will force a delay. Both options include the possibility that the UK extends the timeline to allow for a democratic process, likely a general election, or even a second referendum. A ‘no deal’ outcome is certainly still a risk . . . however, we do not consider a ‘no deal’ outcome a central scenario.”

IMF’s global economy outlook is trimmed — The latest update to the IMF’s World Economic Outlook blames trade uncertainty for trimming growth expectations from 3.3 per cent to 3.2 per cent. While 2020 global growth is seen picking up to 3.5 per cent in 2020 (down from a previous forecast of 3.6 per cent), the IMF notes:

“Risks to the forecast are mainly to the downside. They include further trade and technology tensions that dent sentiment and slow investment; a protracted increase in risk aversion that exposes the financial vulnerabilities continuing to accumulate after years of low interest rates; and mounting disinflationary pressures that increase debt service difficulties, constrain monetary policy space to counter downturns, and make adverse shocks more persistent than normal.”

What also sticks out from the IMF’s update is that EM growth is projected to fall to 4.1 per cent this year, a decade low. As the FT’s Steve Johnson writes, this is the second-weakest figure since the dotcom bust of 2002, rather than the 4.4 per cent the IMF pencilled in as recently as April.

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