Global Weekly: All eyes on the G20

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Now that central banks have moved towards a looser monetary stance, all eyes are on the G20 summit in Japan this Friday and Saturday. It is very difficult to predict what the outcome will be. Investors could respond positively if trade tensions lessened, as this would have a mitigating effect on the global growth outlook.

Meanwhile, geopolitical tensions between the US and Iran keep growing. This, together with a big drop in US crude oil inventories and a potential trade truce, has caused oil prices to go up and energy stocks to outperform the broader market. We are currently neutral on the energy sector. Our position in gold continued to do well in the current market environment, in which we note downward pressure on interest rates and a somewhat weaker US dollar.

There was quite a bit of company news this week. In health care, Bristol-Myers Squibb announced it was forced to sell its psoriasis drug Otezla to complete its acquisition of Celgene on time. The same sector saw AbbVie put in a bid for Botox maker Allergan, in return for both cash and shares.

On Wednesday, the S&P 500 Semiconductors Index also recovered somewhat, with the sub-sector benefiting from the results posted by Micron Technology. The American flash memory maker revealed better-than-expected numbers and reportedly resumed some of its shipments to Huawei Technologies. FedEx, the US bellwether company, also beat expectations, but investors might continue their wait-and-see mode if global trade does not improve.

Lastly, Capgemini announced its acquisition of Altran, an engineering consulting company – a strategic move appreciated by investors. The second-quarter earnings season will formally kick off in three weeks’ time, and we will have to wait and see how companies expect to be doing in light of the growing uncertainties.

Equities – All quiet in the run-up to the G20? Not at all.

For bond markets – and frankly for all other financial markets as well – a lot is riding on the outcome of the G20 summit this weekend, at which China’s president Xi will meet US president Trump to undoubtedly discuss their conflict on trade.

Most investors assume the outcome will be a bit of a non-event, with no clear indication on whether the disagreement will dissipate or could yet flare up. Any other, really tangible outcome is likely to be either cheered or booed by the markets. So why does the outcome of this conflict matter so much? Well, the hard macroeconomic data suggest that the recent sudden flare-up in tension is wreaking havoc on global confidence indicators that typically predict economic outcomes further down the line (and quite accurately, too). Does this mean that the summer will bring poor economic numbers? Most likely, yes, but the question is whether this will matter to bond markets.

In recent weeks, we have seen central banks gearing up their potential firepower to combat any downturn. The Fed is getting ready to cut rates and the ECB might well follow suit, while also perhaps restarting its asset purchasing programme (quantitative easing, or QE). The problem for euro bond markets is that yields are already very negative, so taking cover in this ‘risk-free’ market is in itself risky – if interest rates do not go lower, we are looking at guaranteed losses. Consequently, most fixed income investors are buying riskier bonds, such as corporate bonds or peripheral government bonds, which still generate tiny positive yields, but which come at the risk of a stampede to the exit if markets lose faith. Buying riskier bonds now is to take a bet on central banks managing to once again save bond investors from negative returns.

Bond markets have generated tidy returns this month and in the year to date, and the question is whether this can last? The thing to remember about bonds is that we already know the cash flows that its holder will generate when keeping them to maturity. If, during the lifetime of the bond, the investor is able to sell and make more than they would have otherwise earned, because interest rates or risk premia (credit spreads) turned south, they are bound to earn less further down the line, as these cash flows are only brought forward. The unfortunate truth is that bond markets become less attractive when interest rates and risk premia continue to fall.

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