End of June, it is the end of second quarter and half of 2018 is gone.
What we have learned so far?
First of all, over the past few weeks, it seems more realistic that Trump is not simply bluffing. The trade war is fasting mounting up a tit-for-tat retaliation. At this stage, even if the escalation is only a way to better negotiate bilateral agreements between USA and China or Europe, the secondary effect is not negligible anymore. A wide spread of uncertainty could deteriorate the business sentiment. In fact, we are approaching the earning season and this would be a real test to investigate whether the US companies are delaying their investments targets by losing confidence in one of the best positive trigger of latest economic phase: the synchronised global economic expansion.
Overall a strong dollar, combined with rising raw material costs from tariffs together with higher Oil prices, could negatively affect companies’ margins and influence their ability to export. On the other hand, Europe is fighting with an immigration issue that left the national borders to reach the heart of the Old Continent. So that at the moment the problem has been translated from Italy straight to Germany with a potential government crisis.
Last but not least, China is already facing a bear market, with Shanghai index on pace for worst year since 2011. Also in other periods we highlighted some sources of potential instability for the markets but we often smoothed our bearish view by taking into account the importance of flows. In particular, we took evidence of stronger inflows into the equity world as the most profitable asset class able to attract outflows from the fixed income space. Gradually, the investment grade and then the high yield started to reprice to new levels. But if we analyse the flow data compiled by Bank of America Merrill Lynch, we notice a significant rotation. Investors, by adjusting their allocation, are preferring to navigate difficult waters, by selecting safer assets such as government bonds or even cash, leaving the most risky assets. It was a trend that persisted during the entire quarter but that exacerbated during last days. In fact, according to BAML, in the week ended on Wednesday, investors withdrew nearly $30 billion from global equity funds, which was the second largest weekly outflow on record. Looking at the data, it seems crucial that the substantial amount of equity outflows came from U.S. equity funds, where investors withdrew $24.2 billion over the past week, that is the third largest outflow ever.
In this case then, we have a combination of several factors:
- We are approaching the end of the European QE,
- The FED is set to hike interest rates 4 times during the year
- The market is already pricing a different environment for the investment grade and the high yield corporate bond
- The outflows are no more supporting the risky assets. In particular we are assisting at a pure deleveraging rather than a simple risk off mode.
This is just to summarise few points that are together bear the idea of adopting a more cautious stance in approaching these markets. Defensive themes or secular trends ideas should be preferred in the current asset allocation, unless having a clearer perspective after the upcoming macro data and companies results. A lack of visibility at the moment is the main cause of current market weakness.
Christian Zorico: LinkedIn Profile