European markets have started 2016 poorly. The concerns that were already mounting in the second half of 2015 have actually worsened. American politics seem a worry but European politics are also getting worse. Economic data has not been too bad, but it also has not pointed to an acceleration of growth, which might normally have been the case given the scale of monetary stimulus measures. Indeed, the increasing trend towards negative interest rates opens up a Pandora’s Box of scary scenarios, especially for banks.
In the world of company results, recent reports have been satisfactory – a word that is deliberately meant to imply “good enough for now”. A case could be made that everything is ticking along, provided you have patience.
The fast money quandary
That, sadly, is where it all starts to go a bit wrong. Very few investors have enough patience any more, especially among fast-moving exchange-traded funds (ETFs), commodity trading advisors (CTAs) and high-frequency trading (HFTs). Furthermore, if quantitative easing (QE) is no longer working, or can’t do enough, what will? In fact, there may be more that central banks can do, and the better – admittedly still not great – fiscal position of governments may mean that we could see further moderate stimulus efforts.
But it all boils down to a lack of progress in Europe. The region is forecasted to grow at about 1.5% in 2016, while the US is also dull, China is slowing and Emerging Markets are slower. It is what we have all been warned to expect for some time: a world of persistently low growth.
So what is happening? Evidence suggests that we are seeing a process of acclimatisation for markets – bonds and equities. This also explains the violent rotation between sectors (look at UK mining companies, or oil stocks). Eventually we will, in my view, settle into this new reality of subdued growth.
Is that a terrible scenario? Not necessarily. It is possible to find growth in a low growth world. This can be driven by companies, individuals or governments looking to improve efficiency and out-source certain areas of their operations. Another obvious source of growth is demographics – healthcare and the need for individuals to save for their own retirement.
The Brexit Issue
In my opinion, politics has already reared its (very) ugly head this year and, sadly, is likely to remain a problem. The referendum on whether or not the UK will remain as a member of the EU will be held on 23 June. It may seem odd to those not living in the UK, but sadly, there is widespread support for an exit among Conservative MPs, many of whom would prefer that the UK jumped into a time machine and went back 150 years. There is a very real risk that the UK could vote to leave the EU, in which case the UK economy would undoubtedly suffer – one thing that both the “ins” and the “outs” agree on. The outs maintain that a short transition will ensue, before the UK economy returns to sunnier climes. Unlikely; however, the uncertainty caused by the vote may hinder any signs of real progress for markets for the time being.
The ECB – doing its job
My view is that the European Central Bank (ECB) did more than enough to meet expectations, with cuts to its main interest rate to zero from 0.05%, its bank deposit rate to minus 0.4% from 0.3%, as well as the expansion to its quantitative easing program from €60bn to €80bn.
This was not a repeat of December’s “disappointment” – the ECB has basically thrown a lot more at the problem of low growth in Europe. Clearly there will be criticisms of negative interest rates and the impact thereof on banks – and hence the new Targeted Longer-Term Refinancing Operations (TLTROs) to try and mitigate that effect. The market was apparently spooked by Draghi’s comment that the ECB will not cut rates further – again, in my opinion, that might have been a smart statement. Not only are there signs that inflation is picking up in the US, but Draghi still maintains that inflation will be closer to the ECB target of 2% during 2017 – admittedly way later than expected. So the end of declining interest rates might actually be a sign that normality (the ‘new’ normal – a world of low growth) has returned. Further negative rates will not help anyway if demand is weak and overcapacity exists.
And this is the crux of the matter. To be cynical and coin Keynes’ line, the ECB has given another huge push on the piece of string. Draghi is more subtle, referring to the fact that there is only so much the ECB can do, and confirming what I have been saying recently, namely that the fiscal position and attitude of governments across Europe is slightly easier than it has been. All in all, it is not “boom time” for the economy, but it is “satisfactory” or “good enough” – as good as it gets for now in the new low growth world. It is certainly way better than the crisis levels of a few years ago.
Look also at what happened to German 10 year bund yields. At the end of February they were close to 0.1%. What a prospect – 10 years of minimal returns compared with an average yield of 3.5% or more from European equities. Today bunds are yielding 0.3%. Maybe the bond market gets it.
I think European equities could rally further. In my opinion, politics remain scary. The Brexit debate nasty and utterly misleading by the “out” campaigners, and everywhere in Europe the protest vote is rising. But companies are doing well and meeting expectations.