Global Weekly: Calm before the storm?

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For the first time, the S&P500 ticked the 3,000 points level and also the European Stoxx 600 is approaching the highs of 2017 and 2018. The main driver this week was the US Federal Reserve, where chairman Jay Powell was clear in his statement to the US Congress that a rate cut is very likely. Manufacturing, trade and investment are weak all around the world, he said. This would be the first rate cut in a decade for the Fed. With lower interest rates on bonds and cash, equities should become relatively more interesting.

Chemical giant BASF warned of a slew of issues that took a toll on its second-quarter results, including slowing auto sales and North American farming woes. The underlying problem seems to be the global economic slowdown in combination with and partly caused by the ongoing US-China trade dispute. Typically, you would then expect a warning from more companies in the days before the earnings season starts, as this is an underlying problem that could affect many other companies. But the number of profit warnings is not exceptionally high. In the meantime, the equity market makes new highs. Is this the calm before the storm? The second-quarter earnings season will kick off in a few days and will probably give more insight on this inconvenient situation.

Looking back to the first quarter, the consensus among analysts was very cautious. They expected a 2% year-on-year decline in earnings per share (EPS) for the S&P500. The actual EPS was surprisingly more positive with a 3% rise. The much higher EPS was largely driven by healthier margins than expected and continued buy-backs. Non-cyclical health-care companies have beaten expectations the most, while especially China-exposed companies from the materials and industrials sectors disappointed.

For the coming second-quarter earnings, the consensus is again not positive. On average, a 2% year-on-year decline is expected, which would mark the first EPS decline since the EPS recession from almost four years ago (the third quarter of 2015 until the second quarter of 2016). Just like in the first quarter of this year, analysts mostly downgraded the EPS guidance for the industrials and material sectors. With the US economic surprise index reaching new lows and PMIs on lower levels, chances that second-quarter earnings will surprise just like in the first quarter, are lower. Next week will tell. Then, 24% of the S&P500 will report, among which big names such as Goldman Sachs, Johnson & Johnson, JPMorgan, ASML, United Health, Microsoft, SAP and Schlumberger.

Bonds – The Fed’s accommodative tones

Signs that the US Federal Reserve may begin reducing policy rates, has provided a sizeable tailwind to US fixed income markets over the last two months. At this point, however, a substantial amount of Fed easing is already priced in: markets expect one 25 basis points rate cut later this month, and two more by the March policy meeting.

US Fed Chair Jay Powell, during his semi-annual testimony on monetary policy, expressed his accommodative approach and is open for rate cuts. So, with the Fed easing already discounted to a certain extent, and with US labour markets holding up reasonably well, the question is: should investors hold onto their US Treasuries, or is cash the better option for de-risking portfolios at this stage of the economic and policy cycle?

Based on history, the answer seems to depend on holding periods: over the near term, duration can continue to outperform cash, even if the economy avoids recession. Further ahead, cash should outperform when the economy rebounds.

In Europe, the question investors should answer is: can you, and should you, buy negative yielding bonds. Last week, even non-investment grade bonds saw that certain high yielding bonds could enter into negative yield territory. Negative yielding bonds are forcing investors to take more risk, driving them into investments that do not strike the right balance between risk and return.

A correction of these dilemmas is not yet to be expected, due to the looser policy of most central banks. The coming six months, markets will be in the grip of further expectations for Fed cuts and broad ECB easing, and of global growth and politics, such as the US/China trade tensions and Brexit. It appears that uncertainties around trade tensions and concerns about the strength of the (global) economy, continue to weigh on growth and its outlook. Central banks, however, expressed their readiness to act.

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