US-China Trade War Effect on the EU

US-China Trade War Effect on the EU

Back in March we introduced and briefly discussed Trump’s intention to impose tariffs on steel and aluminum goods. In less than a year those trade disputes escalated in a trade war, impacting not only the two involved countries but also other trading partners, including the EU. The disaffection versus international institutions has been driven by their inability to include the weakest parts of the population from feeling the benefits of the globalization process. While globalization has triggered economic growth and substantial real income growth in developing countries, the middle class of developed nations has not experienced the same benefits, leading to a decrease in purchasing power and a rise in protectionist sentiment.

1

The main idea behind Trump’s rhetoric was to reduce the large trade surplus China has with the United States. Trump previously described the widening deficit, which Washington has said is around $100 billion wider than Beijing reported, as “embarrassing” and “horrible”. China and the EU were among those expressing their concerns regarding steel and aluminum tariffs and have threatened the US with applying a number of countermeasures. Jean-Claude Juncker, President of the European Commission, announced that the union will engage in a collective response with other countries affected by American measures and expressed EU’s intention to draft a list of retaliation tariffs amounting to $3 billion.

Since then, Trump’s actions have shaken the very foundations of global trade, with billions of dollars worth of goods from the EU, China, Mexico and Canada. The protectionist measures imposed by the American president have escalated into a full-fledged trade war between China and the US. An economic showdown between world’s largest economies does not look great for anyone and the EU’s manufacturing and industrial sectors are largely affected. Clearly, those sectors are monumental for Germany – the world’s fourth largest industrial nation.

2

Potential Paradigm Shift?

As the US is escalating the trade war, it will be more difficult for China to accommodate American demands. There are few effective ways for China to retaliate without hurting its long-term development. An alternative would be to open up to the world’s largest economy to the EU. Thus, there is an expectation of a possible collaboration between China and the EU, given that China accepts the longstanding demands of the EU on better market access and give-and-take approach. Within this scenario we would observe a paradigm shift in terms of US-China economic relations. The EU Commission currently maintains a neutral stance towards Chinese exports. So, the result would largely depend on whether EU chooses to align with the US to protect its market from the Chinese market or maintain the neutral policies. By maintaining the neutral stance, EU could substitute the US and China in each other’s markets to an extent. Given that US does not hit the EU directly and EU maintains a neutral stance, potential gains for EU industries are relevant for the motor vehicles and aircraft sectors as well as other sectors combining over $200 billion altogether.

Germany’s GDP Growth

In the third quarter of 2018, German output contacted for the first time since 2015 and this helped push the euro zone growth down to just 0.2%. This weakness is expected to continue in 2019, with the German GDP Growth rate revised down from 1.8% to 1% due to the global economic slowdown. Furthermore, the euro zone does not have the economic backdrop to increase rates, since the ECB ended its net asset purchases in December. Therefore, the benchmark rate is likely to remain the same, making it harder for the EU to offset the effects brought about by the trade war.

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The main factor contributing to this contraction is the German auto industry. German car production decreased by 7.4% quarterly and this subtracted 1% from expansion in the industrial production and 0.3% from Germany’s GDP growth. The reason for this decrease comes partially from the new environmental standards for passenger cars, as producers could not make the vehicles as quickly as they desired.

Another reason for the Germany’s GDP slump might be China’s economic slowdown as China is one of Germany’s largest trading partners. China is facing economic issues arising domestically due to financial instability and externally given the trade tensions with the US. In October, China’s financial team went into overdrive with ten meetings within two months and Vice-Premier Liu He’s team was under pressure to resolve problems caused by the trade war that slowed the country’s growth. China’s economy officially grew only 6.4% on YoY basis in the fourth quarter, its slowest rate since the global financial crisis. A lack of growth in investments and consumption is the main driver of this lackluster performance.

4

Weakness In The Car Industry

Back in June, Germany’s Daimler cut its 2018 profit forecast, while BMW stated it was looking at “strategic options” because of the trade war. Thus, the companies sparked fears of earnings downgrades in the auto industry. Daimler stated that import tariffs on cars exported from the United States to China would hurt sales of its Mercedes-Benz cars, resulting in slightly lower EBIT for the year. Morgan Stanley’s analysts added that Daimler will not likely be the only Original Equipment Manufacturer (OEM) to reduce its guidance. Other OEMs are exposed to similar trends in various degrees.

Daimler’s rival BMW, which also exports from the United States to China and Europe reaffirmed the profit forecasts, adding that these would largely depend on unchanged global political conditions.

 “Within the context of the current discussion concerning additional tariffs on international trade, the company is evaluating various scenarios and possible strategic options”.

European Central Bank’s Hard Work

Mr. Draghi of the ECB and Mr. Weidmann of the Bundesbank seem to agree that the policy should be normalized without delay. This suggests that the ECB remains determined to end net asset purchases by the end of 2018. Still, German exporters are vulnerable to the slowdown in external demand and the risk of trade tensions between Europe and the United States.

So, what should the ECB focus on? The Quantitative Easing program launched in 2015 with the intention to reduce the risk of deflation has come to an end last December. The key EU Inflation Rate rose above the ECB’s target of close to but below 2% for 2018, making it harder to justify an extension of the QE program.

5

The ECB held its benchmark refinancing rate at 0 percent on October 25th and said it would stop to make net purchases under the asset purchase programme at the end December 2018.

This situation has changed in the past months as the effects of the Trade War have been felt on both the real economy and financial markets globally. The sharp slump in energy prices, a contraction in Exports and finally Consumer Sentiment drifting lower from high levels have consistently reduced Inflation and GDP Growth expectations for the EU Area. As a result, it is highly improbable that Mario Draghi will be able to follow through on ECB plans towards normalization in the short term. The continued reinvestment of the proceeds from bond redemptions will be necessary to provide stimulus to the European economy for the years to come. Moreover, ECB should use the forward guidance to thrust back market expectations over the key interest rate rise – something which would weaken the euro and further loosen the financial conditions. The ECB’s next moves largely depend on the upcoming levels of inflation and economic activity, which are linked to politicians’ ability to solve trade disputes and restore confidence.

Trade War Detente

China and the US have agreed to not impose new tariffs up until March, when a definitive agreement is expected to be reached. Furthermore, China’s Ministry of Finance removed the 25% tariffs on American-made cars and 5% on specific car parts for three months. This shows the willingness of both sides to cooperate and work towards a larger trade deal, but only time will tell whether this willingness will convert into a desirable outcome. As commentators pointed out, any positive cooperation including negotiation or even talking would help settle the markets, while continuing tensions will instigate investors to withhold their money.

Even if according to the United States Trade Representative several outstanding issues remain, the possibility of an expedited trade deal has helped stabilize the markets in the last weeks.

6

 The Dow Jones Industrial Average gained 163.08 points (0.7% increase) to 24,370.24 – its highest level since December 13.

The upcoming elections of 2020 in the US oblige Trump to find an agreement in order to maintain his electoral base and increase his probability of reelection. According to reports from various sources, US officials are willing to grant China sizeable concessions in further negotiation rounds to reach an agreement before the deadline. It is unknown if this is enough to restore confidence in the system and the first test is expected in few months on the other side of the Atlantic Ocean. In May there will be the elections for the European Parliament, with Eurosceptic Parties gaining ground thanks to the widespread economic malaise exacerbated by the Trade War. The March meeting proves to be essential for all the parties involved, making extremely hard to forecast future upcoming events.

Authors: Nikita Borzunov, Mario Stopponi

The website and the information contained herein is not intended to be a source of advice or credit analysis with respect to the material presented, and the information and/or documents contained in this website do not constitute investment advice.

 

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Mifid II: what about the markets?

Mifid II: what about the markets?

3rd of January 2018, while the markets started well their year and were keeping a bullish direction before the recent increase in volatility, something else started. Yes, it’s the new European Union Markets in Financial Instruments Directive known also as MiFID II.

Most people talked a lot about it during the last quarter of 2017 and were trying to understand the possible opportunities and threatens related to this topic. But first, let’s see what it is about.

 

The Directive

The aim of this big EU directive (more than 7000 pages) is to protect investors and make sure they receive “fair” deals when dealing with Fund and Asset Managers and so try to make Financial Institutions more transparent. This happens thanks to reports filled within 15 minutes from the transaction so that the regulators can spot abuses in all existing asset classes (Bonds, Stocks and Derivatives) and consequently become more diligent.

A major related change is for Bonds and Derivatives as they will not be any more phones involved in those processes, but everything will be done electronically. In this way, the EU wants to push back a lot of trades to public exchanges so that they can be monitored.

On the Equity side, EU was pushing for stricter limits regarding dark trading but at the last minute it was set back, probably to broaden this aspect, making still possible to trade more than 600 stocks on dark pools. The dark pools are basically private exchanges or forums for trading securities not accessible by the investing public. In those exchanges there is no transparency at all and are mainly used by institutional investors who do not wish to impact the markets. This is confirmed by Trista Keller’s (Bloomberg) statement which says: “For a lot of people MiFID II has still not happened, at list on the equity market”.

Mf1

 

With this little, simple and effective table published by Bloomberg, we can have an overview of the rules that the European regulator introduced and the result that should therefore arise.

Mf2

 

The implications

Let’s now look at the implications of this directive. First, different studies showed a decrease for Research inside banks, both in budgets and in people. Therefore, many professionals of the sector decided to leave earlier to create their own firm. This because an increasingly large number of leading asset managers already announced they will internalise the cost of research in their P&L instead of charging it separately to investors via Research Payment Accounts which are accounts exclusively created for the clients to put funds in to pay for research and directly managed by the financial institutions and banks. A McKinsey report estimated a 10-30% reduction in buy side’s external payment for research over the next three years and a S&P survey indicates that, asset managers’ EBIT may decline by 15%/ 30% because of the shift to P&L accounting for external research expenses.

From the following chart, the first impression is that big banks need a lot of information and their demand seems very fragmented. However, 20 banks account for 64%. Therefore, according to 80:20 Pareto’s rule, one can dominate the market by providing reports of Equity Research to a small number of big players.

Mf3

Moreover, the impressive decrease in European Research budgets both in terms of advisory and brokers, could lead to a big change in banks demand.

Mf4

Another big effect is on Sales&Trading which last year has seen a declining number of traders together with an introduction of electronic trading engineers. Indeed, specific data compiled by McKinsey on the Equity segment of the top 9 investment banks show the overall Sales&Trading headcount declined three times faster than Research since 2011. For example, Goldman Sachs’ US cash equity business moved from 600 traders in year 2000 to only 2 traders in 2016.

In fact, with MiFID II will cause lot of job loosing but at the same time many have been, are and will be created. For example, the number of job adverts on LinkedIn for MiFID-related roles has more than quadrupled in the last year in a sign of how companies have been trying to be well prepared for the far-reaching European regulation. Banks, asset managers, consultancy and law firms have all embarked on a hiring spree ahead of the introduction of the second instalment of the Markets in Financial Instruments Directive.

This is quite a revolution happening in banking which is also related to Fintech and Robo-advisory recent success among investors. Indeed, this disruptive companies are recently receiving large funding from high-profile investors and hiring new talents to take advantage of growth momentum.

 

Winners

Until now, MiFID II has created some advantages that benefited some players such as:

  • Pension funds and family offices will be advantaged as they will be more aware of the fees payed for researches and so increase their bargaining power. Regarding the price, also big money managers such as BlackRock and Vanguard Group will benefit.
  • Platforms in general will benefit from this directive and particularly in hedge funds where they will ease compliance and reduce again costs.
  • Individual investors will be more aware of the fees and this might lead to a big shift from funds to ETFs due to their lower cost. Indeed, they are forecasted to surge from 725 billion dollars to more than $1 trillion in next 1 to 3 years.
  • Big Investment Banks will be able to compete on prices for research eventually building a new revenues stream.

Losers

As any other piece of legislation, MiFID also created some “losers”:

  • Smaller companies with lower budgets will encounter higher prices for obtaining information and may charge higher expenses to clients which could cause a negative impact on business. The same goes for smaller investment banks and boutiques that cannot afford a war price on their research products.
  • Hedge funds will have to insert reports within 1 minute for the equity side and 15 for the fixed income products. This will probably impact their transaction volumes and costs in terms of time and money.
  • Research teams will shrink and so their effort higher or the output poorer. Are unexperienced investors ready to independently search for stocks without being able to rely on recommendations? Will they take the risk or miss the opportunity? What would happen to the relatively unknown small cap? Would the capital run towards big firms leaving the small ones illiquid? As trades would not be any more done over the phone but via platforms, who will now loose his voice and go to the doctor? And what about the already declining fixed phone business?

 

 

Authors

Lorenzo Bracco

Spain Overview: Economic Analysis and M&A Market Trends

Spain Overview: Economic Analysis and M&A Market Trends

Overview of the Spanish Market
Spain has the fourteenth-largest economy by nominal GDP in the world, and it is also among the largest in the world by purchasing power parity. The Spanish economy is the fourth-largest in the European Union, and the fourth-largest in the Eurozone, based on nominal GDP statistics (GDP 2016: $1252 trillion). Following the financial crisis of 2007–08, the Spanish economy’s plunged into recession, entering a cycle of negative macroeconomic performance. Compared to the EU’s and US. average, the Spanish economy entered recession later (the economy was still growing by 2008), but stayed there for longer. The economic boom of the 2000s was reversed, leaving over a quarter of Spain’s workforce unemployed by 2012. In aggregate terms, the Spanish GDP contracted by almost 9% during the 2009-2013 period. The economic situation started improving by 2013-2014. The country managed to reverse the record trade deficit which had built up during the boom years attaining a trade surplus in 2013 after three decades of running a trade deficit. The surplus kept strengthening during 2014 and 2015. In 2015, the Spanish GDP grew by 3.2% (one of the highest among the EU economies in 2015). In 2014-2015 Spain was able to recover 85% of the GDP that went lost during recession (2009-2013). In all the quarters of 2016 was registered a strong GDP, with the country growing twice as fast as the eurozone average. According to the IMF forecast, Spain will recover in 2017 all the GDP growth lost during the economic crisis, exceeding for the first time in 2017 the output level that had been reached in 2008.

Economic Forecast: Steady GDP growth for the 4 next years.
Fiscal stimulus and the ease of monetary policy from the ECB has contributed significantly to the growth of Spanish economy in 2016. With a growth of 5.5% over 2015 Spain’s GDP is expected to keep growing at a slower but steady pace for the next 4 years with domestic demand leading the recovery.

Spain GDP

Labour market: An improving but still challenging environment
The recent reshaping of the labour market through a series of reforms actuated by the new government has contributed to improve Spain labour market conditions and to put it in a strong position to capture future growth. Anyway, with an unemployment rate still at about 19% Spain is the second worst economy of the Eurozone in terms of unemployment, with youth unemployment posing a particularly acute challenge for the future of the economy.

Spain Unemployment

Fiscal policy: “little room for future fiscal stimulus”
With a public debt around 100% of the GDP and a deficit slightly below 5% of the GDP Spanish authorities have little room for fiscal expansion. After two years of significant easing of fiscal policy Spain has to find out a way to stimulate growth by shifting the structure of taxations towards growth enhancing initiatives such as education and R&D that are still below levels of peer countries after having been reduced significantly during the crisis.

Political situation: “achieving stability following 1 year without a real government”
After a year without a government Spain has finally achieved a stable political situation. The measures adopted to tackle budgetary austerity and labour market performance appear to have paid off as the economy is expected to grow by 3%. With a government in place, Spain is well prepared for further growth in a European environment where access to cheap financing is available. Furthermore, M&A activity has increased significantly following legislative changes in 2015, which aimed at facilitating the capitalisation of debt and the acquisition of business units from insolvent companies.

Sources:  OECD outlook on Spain economy, Grant Thornton European M&A activity report

 Deals Volume in 2016
The Spanish economy has continued growing during 2016. In 2016, Spanish M&A transactions totalled a range between €88bn[1] and €111bn[2]. The total deal value in Europe reached an amount of €1.502 bn: the Spanish market represented 5,9% of the total deal value in Europe. The increase shown in 2016 was encouraged by factors like those presented in 2015: continued economic growth; low interest rates and increased market liquidity; negative inflation; foreign trade balance; and stable risk premium for the Spanish sovereign debt. According to the M&A Attractiveness Index drawn up by the M&A Research Centre at Cass Business School, Spain has climbed several positions in the ranking of the most attractive countries for M&A purposes.  Spain fell to 26th position in 2012, but is now ranked 16th. If we break in details the total amount of transactions made in 2016 per size and per Inbound and Outbound, we obtain these numbers[3]:

Mid-market transactions showed a 43.5% increase compared to 2015.  Large-sized and small-sized transactions showed a slight increase in value of 4.5% and 1.1% respectively. Inbound investments increased in number during 2016.  The number of foreign acquirers of Spanish companies increased by a remarkable 9.3% compared to 2015 and outbound investments increased by 25.4%.  The most active sector in terms of M&A deals was real estate which increased to 11.6% compared to 2015.  In general terms, the real estate market continues growing as big banks keep unloading assets and tax structures such as Spanish Reits (SOCIMIS) and collective investment vehicles remain appealing to domestic and foreign investors.

Spain Sector

The main M&A transaction that took place in 2016 in Spain was the merger of the Coca-Cola bottling companies for an amount of €20bn.  Coca-Cola Enterprises CCE.N combined with Coca-Cola Iberian Partners (CCIP) and the German bottling business of Coca-Cola to create a new company that is the world’s largest independent bottler of Coke drinks by net revenue. The transaction gave new company, Coca-Cola European Partners (CCEP)[4].

According to the data collected by Thomson Reuters, the top actors per value and numbers are[5]:

Spain M&A Actor

The two Spanish banks Santander and BBVA do not owe their position to any concrete operation. On the contrary: their situation has been created thanks to the sum of many transactions of medium size. “This year has been one marked by the lack of big transactions, but characterised by mid-sized deals”, indicates an executive of a financial institution. “Banks which have the capacity to reach this segment have been very active”, he adds[6].

This lack of big transactions is reflected also on the deal volume of big American banks as JP Morgan and Goldman Sachs. In 2015, the last one was first in this ranking made by Reuters and now it is eight losing 6% of market share. Others American banks have kept their position and in particular Citi is gaining position in this ranking.

Outlook – Trends
One of the biggest player KPMG expects the M&A market in Spain to perk up based on the favourable development of the Spanish economy[7]. According to them investors regained their faith in Spain and see it as a reliable market with an abundant amount of liquidity. In particular, the interest of investors is driven by market growth expectations, legal security, the global importance of Spanish companies and the new reforms that make the Spanish economy more competitive[8]. A study conducted by KPMG shows that investors are 7% more confident to realize M&A activity in 2017 compared to year before[9]. Furthermore, the M&A market capacity is expected to be growing by 14% compared to 2016. Concerning the importance of the sectors, KPMG foresees that most M&A activity will be in consumer goods, health and finance. Consequently, they also expect the number of IPOs to increase. A partner of Magnum Capital, a leading private equity enterprise in Spain, the Spanish M&A market didn’t use its full potential due to uncertainty of the effects of the Brexit and the political instability in Spain[10]. Therefore, his forecast for 2017 is very positive mainly based on the fact that many operations were stopped in 2016 and are expected to be closed in 2017. Baker McKenzie, the second biggest law firm worldwide and specialized in commercial law, predicts the M&A activity to grow by 41% until 2018[11]. This is mainly explained by the competitive advantage resulting out of the labour reform in 2016 that is resulting in growing employment[12]. Also, they expect the IPO activity to grow significantly during the next three years based on the difficulties in 2016[13].

Main challenge of 2017:

1. The first is the normalization of the labour market. The unemployment rate is finally below 20%, and the Spanish economy has been outperforming the rest of the eurozone since 2015. But the good labour market performance cannot hide an hysteresis effect that is changing the quality of the labour market. A real long-term unemployment problem is emerging, together with the loss of human capital that this entails. This means that employability is decreasing, and that much higher growth rates in the future may be needed to keep unemployment on a decreasing trend. The problem of long term unemployment is compounded by youth unemployment, that remains extraordinarily high at more than 40%, and NEET young people can be found especially among the low-skilled, with a serious risk of poverty. Dualism of the labour market is a source of fragility and of insufficient investment and innovation.

2. The second challenge is the fiscal stance, and it is of course related to the debate in Europe. The Spanish government has strongly reduced its net lending (including the structural deficit) that nevertheless remains at around 5% of GDP.  Yet, the Spanish situation clearly needs a more expansionary environment, that could only come from the rest of the Eurozone. Continued austerity will not help with Spain’s most pressing problem, hysteresis and long term unemployment.

3. The effects of the Brexit referendum remain unpredictable.[14] How it will impact the M&A activity in Spain and Europe depends on how Britain will foster the exit and how the process will develop.

 References:

Agencia EFE (2017)

Las fusiones y adquisiciones aumentarán un 41 % en España hasta 2018, http://www.efe.com/efe/
espana/economia/las-fusiones-y-adquisiciones-aumentaran-un-41-en-espana-hasta-2018/10003-3156469.

Argali Abogados (2017)

Spanish M&A surges again despite obstacles, http://www.mandaspain.com/spanish-ma-surges-again
-despite-obstacles/.

Baker McKenzie (2017)

Baker McKenzie prevé para España un aumento del 41 % en M&A hasta 2018, http://www.bakermckenzie.com/es/insight/publications/2017/01/global-transactions-forecast/.

Europa Press (2015)

El mercado de fusiones y adquisiciones resurge en España, según KPMG, http://www.europapress.es/economia/finanzas-00340/noticia-mercado-fusiones-adquisiciones-resurge-espana-kpmg-20150316183707.html

Expansion (2017)

Las fusiones y adquisiciones crecieron un 20% en España en 2016, http://www.expansion.com/
empresas/2017/01/01/58692ab4468aeb670d8b45e1.html

[1] Expansion
[2] Mergers Market
[3] Global Legal Insight
[4] Thomson Reuters
[5] Thomson Reuters
[6] Expansion
[7] This and the following Europa Press
[8] Expansion
[9] This and the following Europa Press
[10] This and the following Argali Abogados
[11] Agencia EFE
[12] Baker McKenzie
[13] Agencia EFE
[14] Here and the following Argali Abogados

Authors:

Virginia Bassano, Luca Pancari, Andrea Terzi, Felix Oliver Napp

FINANCIAL MARKETS: WHERE WE ARE AND WHERE WE ARE GOING

FINANCIAL MARKETS: WHERE WE ARE AND WHERE WE ARE GOING

Having a look at some of the biggest winners and losers on the global financial markets in 2015, Jamaican stocks result to be among the top performers; the island nation’s index rose more than 80 percent. As for losers, the political issues and lower oil prices have hurt the Ukrainian equities index, which has tumbled 56 percent year-to-date.

luca 1

At the same time, on the developed Market, Eurozone equities enjoyed some rallies in 2015, buoyed by the ECB’s bond buying and the weak euro. In terms of local currencies, Europe’s benchmarks did well this year. Investors greeted Italy for finally dragging itself out of a triple-dip recession, but in Spain, fears of political impasse outweighed the excitement surrounding its economic recovery. The commodity rout hammered London’s FTSE 100 as it went down 4.8 per cent on the year.

Luca 2

Had it not been for a small group of nifty companies, 2015 would have entered the history books as a terrible year for the US stock market.

The consumer discretionary sector led the way this year, followed by healthcare. However, energy and materials companies were the biggest loosers due to the decline in price of many commodities. Yet there were some very positive numbers for a group of four companies that have come to be known as the “Fangs”(Facebook, Amazon, Netflix and Google) and for a wider group that included Microsoft, Salesforce, eBay, Starbucks and Priceline to create the “Nifty Nine”.

Both groups gained more than 60 per cent throughout the year.
Part of the reason for that was that profits were declining. This was in large part due to decreasing revenues at energy companies, driven by falling oil prices. But the strong dollar, which hit overseas earnings, was also a factor. In the same manner declining margins played a key role, as wages started a slight recovery. Therefore investments flow mainly to the enterprises that can show strong revenue growth. That is extremely worrying.
Dominance by a few big companies is a symptom of the end of a bull run, as it happened in the early 1970s (dominated by the “Nifty Fifty”) or the late 1990s (dominated by the dot-coms).

luca 4.png
The rise of tech startups with extremely high valuations, as well as the ‘FANG’ group of stocks, has generated much concern over whether or not we are in another tech bubble. According to Goldman Sachs, there is one important difference between the confirmed tech bubble we saw in the late 1990s, early 2000s and today. The big difference is earnings.

During the tech bubble, tech companies never accounted for more than 16 percent of the total index earnings. As January 2016, tech earnings contribute for over 20 percent. Regarding the market cap, tech companies’ accounts for a smaller portion of the S&P 500 in comparison with previous years. In fact, as today, the tech industry’s market cap represents only 21% of the S&P index as compared with previous peak figures of 32%. (smaller market cap of S&P 500, higher earning, hence it is less likely the bubble will repeat itself).

Luca 5.png

FORECAST AND RISKS

 The US stock market has vastly outperformed the rest of the world after the 2008 crisis, accommodative monetary policy helped this to happen. So did the strength of the US economy, while the strong dollar also amplified the outperformance. Yet a too strong dollar might hit the US companies’ overseas earnings while strengthening the rest of the world, and other central banks are now aggressively easing monetary policy while the US Federal Reserve has just started to raise rates.
The growth gap between the US and Europe is starting to narrow. At this point in time, we are expecting Europe to see GDP growth of roughly 1.75 per cent in 2016, against 2/2.5 per cent in the US. This was mainly caused by the rising dollar price that redistributed growth and corporate earnings from the US to Europe. It would be a surprise if in the second half of 2016, the European economic growth accelerates beyond the US growth. Such a result might produce a year of earnings growth for European listed companies, something which has failed to happen since 2010. Stronger Europe growth would challenge assumptions that very low interest rates have become normal.

The UK is expected to follow the US and raise rates by the end of the year, yet Europe is still cutting them. China’s economic wobble (which has deepened the commodities crisis and by doing so, dragged the FTSE 100 down with it) has depressed emerging markets.

Even the political landscape is shifting. A presidential election in the USA and the European referendum in the UK are creating speculations over what “Brexit” or a Trump presidency might mean for investors. The other main risks for this year are Fed’s mismanaging communication of its process, which could have a destabilising impact on financial markets and another round of deflationary pressure exported from China.

 Moreover the world’s major economies are beginning to diverge. The US was the first to begin the withdrawal process from rock bottom rates, but fears remain about its future growth prospects.

Businesses compete for investor money and also offer corporate debt (bonds) to fund operations. If the rates of Treasuries rise due to Fed action or a spread selloff in the bond market, then a company that wants to raise capital must offer higher rates of return on their bonds offerings. This higher rate of return is a larger burden on their balance sheets and decreases profitability therefore they will have lower EPS. Considering also the higher borrowing rates of businesses and consumers, a general slowdown in corporate profits could arise. This slowdown will result in the liquidation of share holdings in search of better investments.

COMMODITIES

For the commodites sector, 2015 was characterised by a strong downward trend.The worst performers were West Texas Intermediate and Brent Crude oil. Metals, such as platinum and palladium were down by roughly 30% along with gold losing up to 10%.

In agriculture, the coffee fell down by 25%, while it was an upward year for cotton and sugar. The collapse in oil prices during 2015 was determined by the slowdown in China’s economical growth and the unchanged Saudi Arabia’s oil production, which has not decreased in order to stop the business of fracking in America. If oil reserves reach the maximum of their production capacity and the oil demand decreases further down, the oil price will suffer further downward corrections.

The general consensus of the Brent’s price for 2016 is 50$ per barrel, compared to the 29$ per barrel at the moment. Furthermore, Iran, free from sanctions, will add to the current level of world production (95 million barrels per day) half a million barrels per day. Three major investment banks (Morgan Stanley, Citigroup and Goldman Sachs) warned that if oil storages continue to rise, the price might reach a minimum of 20$ in the short term.
However, the decline of oil production in the United States, will counterbalance the levels of world production, creating conditions of getting prices to reach the ones agreed in the consensus. Consequently US WTI crude oil is keeping its outlook at $45 a barrel, while for Brent crude oil at $50 a barrel in 2016. Finally major investment banks analysts forecast gold to remain around $1,100 per ounce for the next three months, $1,050 an ounce for the next six months and $1,000 an ounce for the next 12 months.

London, Jan 19th 2016

Luca Cartechini, Head of Asset Management
Fulvio Abbonato, Asset Management Associate

Europe: A Turbulent Snatch? – European Citizen

Europe: A Turbulent Snatch? – European Citizen

In recent days, Europe has been a very dramatic battlefield. Talks between Greece and European officials are still going on, with Greek Ministers firmly stuck on their requests and European Officials unhappy and unsatisfied with Greece’s request. Tsipras does not want to change the pension system, contribution-based, still plenty of “baby retired”. Yesterday, Angela Merkel appeared as a Deus Ex Machina willing of peacefully solving the Greek Crisis. The main goal in Europe by now is to avoid the Euro Area break up, who can lead us into periods of unprecedented uncertainty and volatility, and can wreak havoc the entire Europe. Standard and Poor’s downgraded Greece Debt to triple CCC, following the postponement of the repayment to the IMF and the higher risk of default. Jeroen Dijsselbloem, the President of the Eurogroup, warned against the running out of time, and urged Athens and Europe to a peaceful resolution.

Many venerable European banks have been downgraded too because of the uncertainty over Europe’s financial health. Barclays Bank has been downgraded to A-, Deutsche Bank to BBB+ and RBS to A-, Commerzbank to BBB+ and Unicredit to BBB.

The bond market has been under severe attacks. 10-YR German Bund reached high yield of 1% yesterday. From the bottom in May at 0.05%, this means a 2000% increase. Bond traders are adjusting bond prices to looming spikes in inflation in the Eurozone.

EuroStoxx

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Tancredi Viale