Partial profit-taking in view of the stocks higher valuations

Investment Policy, May 2019

Partial profit-taking in view of the stocks higher valuations

The surge in equity prices since the start of the year has now become so pronounced that a consolidation or a correction cannot be ruled out. This would apply in particular if the financial markets were to be disappointed by certain developments – such as the result of the trade dispute negotiations between the US and China, the Brexit saga, or corporate earnings. The stock market gains of 2019 are above all attributable to a hefty rise in valuations of around 15–20%. If equity markets are to make further notable gains, they will surely require positive rather than mixed data regarding the development of the global economy.

The most recent data pertaining to the macroeconomic environment have been mixed. In the US, retail sales growth has remained below-average compared to the previous year, whereas the ISM Manufacturing PMI has improved somewhat from 54.2 to 55.3. The number of newly created jobs has risen once again, although wage growth has proved lower than expected. A similar pattern of development is evident in Europe, although here the weakness is evident in manufacturing, whereas the picture for services is rather better. The Eurozone’s leading indicator for manufacturing most recently came in at 48.3 – weaker than expected, and indeed weaker than the previous month. There has also been a sharp decline in the EU’s business sentiment index for the industrial sectors, namely from –0.4 to –1.7. By contrast, year-on-year Eurozone retail growth has bounced back from 2.2% to 2.8%. There are still no truly convincing positive economic signals coming out of China. The infrastructure investments initiated by the government have stabilized to some extent, but the key indicator of consumer sentiment – retail sales growth – is clearly below its long-term annual average of 11%. It is important that we see an improvement in the economic data over the next few months, particularly in a very weak Europe.

Equity markets have recorded their best first quarter of the year for more than two decades. But even though certain economic data components have improved, the overall global picture can only be described as mixed rather than genuinely positive. Moreover, the strong stock market gains witnessed since the start of the year are not supported by earnings growth, but are attributable to a valuation increase of some 15–20%. Some sort of consolidation would therefore not surprise us at all. The Fed’s decision to suspend its rate-hiking trajectory is unlikely to drive further market gains going forward. What is needed now is a significant improvement in the macroeconomic environment. In addition, given the strong rise in valuations, the markets will want to see an improvement in the various geopolitical uncertainties, with the Sino-US trade conflict being a prime example. As a third factor, equities need a clear improvement in corporate earnings if they are to chalk up further significant increases. If one or more of these three elements were to disappoint, a consolidation or a correction could result, particularly given the lavish 15–20% price gains recorded since the start of the year. We therefore now believe a certain degree of profit-taking only makes sense. 

Given the increase of some 15% in equity valuations, a consolidation or a correction would come as no surprise.

Gérard Piasko, Chief Investment Officer

The most recent meeting of the Federal Reserve showed how important the monetary policy U-turn has been. Further rate rises are no longer envisaged by the US central bank in 2019, and the reduction of its bond holdings is set to come to an end in September, i.e. the Fed will once again become a net buyer of US government bonds from the autumn onwards. The bond market reacted promptly to this development, as it did to the ECB’s announcement that there would also be no rises in Eurozone interest rates in 2019. The consequence of this development is that clearly negative government bond yields are once again the dominant feature of the Eurozone and Swiss fixed income markets, and in the US too government bonds have declined again. Accordingly, higher-yielding corporate bonds have gained a certain amount of momentum, as investors are logically wondering where positive returns can be generated. Falling rates of inflation are further strengthening this quest for yield right now, and high-yield bonds have been the beneficiaries.

The interest rate differential between the US on the one hand and the Eurozone and Japan on the other continues to be an argument in favour of the US dollar. Another supporting factor for the greenback is the ongoing difference in growth rates between the US and the other above-mentioned economic zones. The economic changes expected by the market consensus likewise remain a positive for the dollar, which could weigh on emerging market currencies. If there is to be any credible euro recovery, we will now need to see plenty of European economic data that exceeds the market’s expectations. Furthermore, it should not be forgotten that US political stability has improved recently with the conclusion of the Mueller investigation into the US President, which has not yet thrown up anything seriously incriminating. On the other hand, European political stability continues to be fragile, both due to the truly chaotic situation in UK politics and in view of the lack of leadership strength in key EU states.

The commodity markets are once again dancing to the tune of oil price developments. The increasing decline in supply from Venezuela, which has already been driving up the price of oil, has now been joined by the risk of a reduction in supply from Libya. US sanctions against Venezuela have been in place since January, and these – combined with electricity outages – have more or less halved the country’s oil exports. Political stability in Libya has deteriorated further with the rebels’ attack on the capital, increasing the risk of production stoppages. Moreover, the bottleneck in pipeline/logistical capacities has yet to be resolved in the US, and this too is holding back exports and contributing to a further restriction on the global oil supply.  

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Editorial deadline: 17 April 2019

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