2018 EU-US Outlook: Where do we come from? What are we? Where are we going?

2018 EU-US Outlook: Where do we come from? What are we? Where are we going?

As the first quarter of the year is headed to the end and new challenges lay ahead for international financial markets, frame the actual situation is necessary to adapt to future changes.

2017 has been a record year both in terms of returns and volatility. Looking at historic data, seems obvious the past year represents an outstanding exception, may have the markets gone too exuberant? Economic and business data do not suggest so, with results exceeding expectations consistently.


ou 2


European Union: Renaissance

The year that just ended has proven the comeback of growth in the economies in Europe. The expansion in GDP and the steady decline in unemployment from the record level of 2011 has spread to Mediterranean countries and gathers speed. France, Spain and Italy have inverted their road joining Germany and northern countries in what can be compared to a renaissance of European Economy.




As over 62% of EU countries’ total trade is done with other EU countries, the interdependency across EU economies has risen to levels which make necessary a harmonized growth to attain lasting results. Moreover, the strong reliance on exports, as testified by the fall in imports between 2012 and 2016 while exports grew in that period, has proven to be beneficial given the harmonized global growth. The EU accounts for 15% of global imports and exports approximately, making it the second world player and a necessary participant to global expansion. Which comes first, global growth or European expansion? The answer is irrelevant, as they influence and reinforce each other in a benign loop. The high levels of unemployment from which Europe started the recovery in 2012 leave space for further expansion, accompanied by low inflation rates which are consistent with an early stage recovery.




Fiscal and monetary policies do not represent a threat, at least now. Governments around Europe share similar electoral programmes centred on the reduction of fiscal pressure and the enhancement of investments. The policy makers at ECB do not want to break the toy by acting too fast deleveraging their balance sheet, but the market is anticipating the end of QE and the beginning of the tightening cycle by end of 2018, beginning of 2019. Low interest rates are here to stay as Mario Draghi said, so the extremely favourable economic environment is going to support Equities through the year. The effects of improved stability can be seen inside Europe, with outstanding levels of consumer and business confidence, and outside Europe, with the Euro-Dollar Exchange Rate moving consistently with the strengthening of European Economies. The strengthening cycle of Euro started in 2017 will continue with the economic recovery, until Euro strength weights too much on exports. At least in the foreseeable future, this is not the case.




Attractive valuations in European Equity offer long term opportunity for investors looking to take advantage of the economic environment. On the other hand, the extreme intervention of ECB in the Bond Market has created distortions in prices with risks skewed to the downside. This means that investors will be exposed to volatility, both in Equity and Debt Markets, once the normalization of interest rates begins in the following years.


United Kingdom: Uncertainty

A big question mark is represented by the United Kingdom: after the Brexit the outlook for UK economy has darkened leaving big gaps of uncertainty. Those gaps will be filled only after the conclusion of the negotiations with EU representatives with the deadline to negotiations fixed in October 2018. The IMF has already cut economic growth forecast for UK, expecting 2018 growth of 1.6%, down from previously forecasted 1.7%, followed by a further slowdown next year to 1.5%. The effects of uncertainty cited by Christine Lagarde, IMF Chief, are the delay in investments and the loss in spending power, caused by rising inflation, falling pound and stagnant wages.




As a result, the UK will live the global expansion only vicariously losing relative strength and power in respect to other countries which offer better opportunities. On the other hand, the UK government will have to counterbalance the possible losses in the financial industry, approximately high net worth 100.000 jobs in the City with cascade effects on housing market, leisure industry and most importantly on tax revenue. The possibilities of actions range from a tax cut to a more generic business friendly environment, with Equities resulting as the most beneficiaries of the situation. Government bonds on the other hand are not as attractive, given the deficit that the UK government will incur to support fiscal policies. The uncertainty already weighting on the Pound will continue until businesses will have clear investment plans to adapt to the changing environment and markets will have enough information to take positions.


United States: Goldilocks

The expansionary cycle started in the US after the Great Financial Crisis does not seem to have stopped, as testified by the healthy 2.3% annual GDP growth for 2017, the steady decline in unemployment rate to 4.1% and the inflation rate of 2.1%.



These are numbers of a country which have abandoned early stages of recovery and has entered the late stage cycle of economic expansion. In this environment fiscal and monetary policies diverge. The Federal Reserve has started the unwind of monetary policies in Q4 2017, by deleveraging the balance sheet from the record level of $4.5 trillion at a rate of $50 billion per month targeting a drop below $3 trillion by 2020. Moreover, the FED plans three rate hikes for 2018 as the normalization process continues, but the threat of inflation picking up at wages level is creating questions whether the FED is already behind the curve. Given the 2% inflation rate target, the FED may be forced to accelerate the hikes before expected from the market, causing turbulence to the new chair Jerome Powell.




In this context, the Tax Plan approved at the beginning of the year by the Congress represents the fiscal lever to counterbalance the monetary contraction. Cutting the corporate tax rate to 15%, President Trump aims to stimulate the economy enhancing job creation, wage growth and investments. The slash of the repatriation tax rate on corporate cash held overseas, from 35% to 10%, is the second major incentive for investments in the country. With $2.5 trillion in cash held by US-owned corporations overseas, it is rational to expect a big portion of it to be reinvested in the US in the form of dividends, buybacks and M&A operations. As the economy is moving closer to full employment, the benefits of fiscal stimulus will likely be constrained because the economy is already operating at near full capacity. Nevertheless, GDP growth is expected to reach 2.5 percent in 2018 and then to moderate to an average of 2.1 percent in 2019-20. US listed companies will see the benefits of the Tax Plan on their balance sheets starting from 2018. According to the most recent estimates by UBS analysts, S&P500 companies will post an increase in earnings of 18% for 2018: nearly half of it, 8.5%, will come from pretax income growth, while the tax cuts for corporations, M&A and buybacks will provide a 9.7% growth.

How much of this positive outlook is already priced in by the market? The S&P500 delivered a 21.7% return in 2017, with no negative months across the year and extremely low levels of volatility, while the first quarter of 2018 has been characterized by spikes in volatility and dispersed returns.




Valuations look stretched here: the Price to Earnings Ratio is above 25 and the Cyclically Adjusted Price Earnings, which takes into account the adjustment for the average inflation from the previous 10 years, is around 32. This does not mean that the market is going to crash, but that returns in the future are expected to be lower as the market is already pricing them in the valuations. The US market has historically been more expensive than the global markets, as it offers both the biggest companies and the highest diversification by sectors. Moreover, the US are the first global superpower by GDP, GDP per capita and international influence, which means that they will always attract more investments and will sell at a higher premium than other countries.


Two major factors to further consider are the Dollar and the Government Bond yield. The 10 Year Bond yield is approaching 2.9%, the first time since 2014, as the market is pricing in the widening budget deficit coming from the Tax Reform and the $1.5 trillion spending of the Infrastructure Plan proposed by Trump in February 2018. The Yield curve, represented by the difference between 10Y and 2Y yields, is downward sloping and consistent with late stage cycle expansion, the Goldilocks period before the end of the expansionary cycle.



The last factor to take into account is the Dollar. Uncle Ben’s currency has started a weakening cycle from the highs of 2017, providing support both to overseas earnings of US stocks and to the FED in reaching the inflation target. As the global economy strengthens, risk-off currencies like the Dollar and the Yen should weaken as capitals flow to riskier countries which provide higher returns.





Mario Stopponi


Everything happening in the Markets: Winners and Losers of 2016

Everything happening in the Markets: Winners and Losers of 2016

Here’s a look at some of the best and worst performing assets in global financial markets as 2016 ends.


British pounds are almost unanimously rated to be the worst performing currency in the year of 2016, which suffered significant devaluation due to the Brexit referendum on 23rd June, 2016. Overnight GBP plummeted, a price UK paid to “leave” the EU. By the end of the London trading session the next day, GBP dropped nearly 9% against the dollar, representing one of the largest single-session selloffs in GBP history. The ride for GBP in 2016 wasn’t a great one, though the value of GBP is expected to stay resilient until further details of Brexit will be revealed.

EUR/USD started with 1.0898 on January 4th 2016, but decreased to 1.0541 on December 30th, despite having achieved the peak of 1.1569 on May 3rd. The average EUR/USD of the year was 1.1062, but it could reach the parity in 2017 as Trump’s expansionary fiscal policies could further strengthen dollar.

EUR/USD Trend 2016 – Financial Times Market Data

With slower economic growth in China, Chinese RMB had its biggest annual loss this year since 1994, therefore the government ended 2016 introducing a new round of capital control measures to help RMB stay strong. The slowdown also weakened the value of Australian Dollar and New Zealand Dollar.


2016 has been a resurgence year for commodities, with the first annual advance since 2010. Thus, the Bloomberg Commodity Index, tracking returns for 22 components, climbed 11% in the past year.

Natural gas is on the biggest fourth-quarter rally in 16 years, prices grew 60% over this year, pushed by expectation of a severe winter. Wheat, on the other end of the spectrum, has been the worst performer tumbling 14% due to rising global stockpiles.

OPEC and 11 other producing countries plan to start oil supply cuts in the beginning of 2017 to reduce swelling global inventories after a long period of unlimited output. Details of agreement implementation are still awaited but oil has made the biggest annual gain since 2009. While economic growth of top user China and Donald Trump presidency, particularly his infrastructure investment plan, are expected to further bolster demand for metals in the coming year. For the first time in four years Goldman Sachs has recommended an overweight position for commodities, raising both iron ore and oil price forecasts. However, signals on the iron ore prices are mixed – plenty of other banks expect them to be back below $50 by the third quarter as Chinese property market may cool.

Brent Crude Oil Trend 2016 – Financial Times Market Data

Trump’s victory had a detrimental effect on gold – it suffered a 13 percent decline in the fourth quarter of 2016, confirming the negative correlation between gold and U.S. stocks. After the dire end of the year, however, traders are once more bullish on gold as it climbs up 2.6% to 1173 an ounce the first week of 2017. Investors also hold bullish positions in cotton, cattle and crude oil, but aren’t optimistic for corn, cocoa and wheat. Overall, a modest recovery is projected for most commodities in 2017 as demand strengthens, supplies tighten and global economic growth picks up.


The year 2016 was a pretty good one for stocks despite political uncertainty coming from Brexit, Trump, and new elections happening across Europe. In UK, The FTSE 100 broke an all-time high on the final trading day of 2016. In the US, the S&P 500 was up over 10% across the year, the return was 12.5% including dividends. That followed the weak performance of 2015, when the index gained just 1.4%. The beginning of the year was challenging for American stocks, when they have experienced a selloff, driving the Dow Jones industrials at 15,500(now 19.970). However, potential Trump’s expansive fiscal policy and a bounce in commodity prices have been key drivers for markets, offsetting the initial tumble. US banks are expected to boost earnings as a result of higher Treasury yields and a more accommodative regulatory regime promised by the Trump administration. The best performing sectors of the S&P 500 were Energy with a +24% return and Financials with a gain of +20%.

Schermata 2017-01-09 alle 12.20.21.png
S&P 500 Energy and S&P Banks Trend 2016 – Bloomberg via Financial Times

While other developed equity markets mostly struggled in 2016. Europe was hit by Britain’s vote in June to leave the European Union and the European Stoxx 600 was down 1.2%. Despite 2016 was the fifth successive annual gain for the Japan’s Nikkei 225, the index was only up 0.5%, partially due to weak inflationary and macroeconomic data signaling a weakening effectiveness of BoJ monetary policies.

Stoxx 600 Trend 2016 – Bloomberg

The best stock index of the year (in terms of U.S. dollar) was the Brazil’s Ibovespa, driven by the new President Michel Temer replacing Dilma Rousseff after the impeachment, and rising commodity prices. The Shanghai Composite index was the worst (-16%), however it was down -23% at the beginning of 2016, due to an initial loss of confidence in China’s economic growth prospects. The falling yuan has driven investors abroad in search of better performance elsewhere.


2016 was a volatile year for government bonds starting with the immigration crisis, followed by Brexit, Trump’s winning and ending with the veto vote in Italy’s constitutional referendum. U.S. Aggregate Bond Index finished with 1.9% in the closing days of 2016 with the expectation of an increase of US treasury yield accelerated after election results on November 8th, the spread between US 10-year Treasuries and German 10-year Bund widened to 2.224%, marking the widest gap since the fall of the Berlin Wall. The gap signals that investors see strong divergence of economic growth in these two developed markets. Across the Pacific Ocean, China’s 10-year government bond yield has fallen from 4.6% in January 2014 to 2.65% in October 2016, one of the lowest points this year, despite the government’s efforts to contain the bond bubble.

Total Return of Global Financial Assets 2016 – Bloomberg via Deutsche Bank



Luca CartechiniHead of Financial Markets
Yiping Zhang – Financial Markets Associate
Kseniya Shitova – Financial Markets Associate

On the Rollercoaster – Yearly Recap

On the Rollercoaster – Yearly Recap

The 2015 has been a very turbulent year for financial markets globally. Greece, the unpredictable oil rout and weak growth perspective in China repeatedly triggered waves of sell-offs during the last year. Here a closer look at the main characters or events that set the trends this year.

S&P 500 Yearly PerformanceSP500


The oil rout has started in the middle of last year, when it collapsed from the range $110/100 a barrel to levels close to the post Financial Crisis lows, $35/45 a barrel. Since the beginning of 2015, Oil has been very volatile, trading in a range between $35 and $65 a barrel. Its unpredictable trend affected financial markets on a global scale. The high-yield bond market is under strict observation after the low prices of oil have been pushing a large number of shale gas companies on the verge of bankruptcy. On December 10, Third Avenue Focused Credit Fund closed its $800m junk-bond portfolio due to the slump in bond prices. The energy sector has been dramatically hit by the rout, forcing layoffs, firm aggregation e.g. (Royal Dutch Shell and BG) and Capex reconsideration. Weaker demands from top-tier consumers as China and consistent OPEC plans to keep production high pushed prices down, weakening inflation expectations in developed countries and increasing risks of deflation. Emerging Markets heavily relying on oil exports have to cope with more than halved revenues from the primary source of inflow, currency depreciation and inflation. Brazil is reportedly in recession, Saudi Arabia disclosed a Balance Deficit of 15% of its GPD, envisaging austerity periods in public spending. Oil will still play a major role in 2016, when the ban on Iran oil exports will be lifted and new fresh oil will flood into the market.

WTI 5 Year PerformanceOilSource: Bloomberg


Being the second largest economy in the world, China has set the trend in many occasions this year. The Stock Market crash sparked fear and volatility all over the world. The Shanghai Composite, after a rapid ascent, it started to fall rapidly between June and August, losing almost 40% of its value. Weaker growth perspectives, decline in industrial production, and weaker demand for commodities, especially copper, dragged down global markets, spilling over other asset classes, especially Emerging Markets local currencies. In order to give China exporters a competitive edge People’s Bank of China devalued the renminbi several times during this year. In August, in the wake of the first devaluation, the Yuan reported the largest daily loss in over 20 years. Kazakhstan’s Central Bank, in order to cope with depreciating rival currencies, decided to shift to a free-floating rate. On August 15, the tenge tumbled 26%. These moves raised the risk of a potential currency war between August and September, which eventually fade away.

CNY/USD Yearly PerformanceYuan RenminbiSource: Bloomberg

In the first days of 2016 a dramatic sell-off in China that triggered the circuit breaker mechanism halting trading if losses greater than 7% materialize, produced a chain effect on the Financial System, resulting in the worst first week of trading in history. The S&P lost almost $1 trillion in market capitalization in the first week.

 Central Banks

The Fed and the ECB adopted divergent strategies in terms of Monetary Policy. Improved economic conditions and a more solid labor market in the US pushed the Federal Open Market Committee to unanimously raise interest rates up to 50 basis points for the first time in nine years. The December hike was broadly expected by all market makers, and paved the way for future hikes in the coming years. The ECB, in the opposite direction, eased the monetary policy in December, lowering the deposit rates at minus 30 basis point and prolonging the quantitative easing up to March 2017, with potential further extension. Draghi’s move disappointed market makers, who foresaw an increase in the monthly purchase of  securities, hammering down European Equities. Despite eased policies, inflation in both region is far from targets and the pressure on oil prices seems to further raise the risk of consistent low prices and deflation. Central Banks will still play a key role in the next year in their effort of improving economic conditions and reaching inflation target.

In the first days of the New Year, negative signals coming from the commodity market and China sparked uncertainty and fear over the stability of the financial system. Will the improved economic conditions in Europe and America be able to offset the downside risks coming from the Chinese transitioning economy?


Tancredi Viale, Master Student