Market trends and perspectives – October 2019

Analysis | November 6 2019

Catherine Wajsman answers a series of questions aimed at understanding market trends in the past quarter and anticipating the next few months.

What are the reasons behind the decision of central banks to implement support measures?

It’s quite simple: in light of current political risks and, above all, increasing trade tensions, central bankers want to curb the economic slowdown seen worldwide and prevent a recession (which, in our opinion, is not in the cards, either for 2019 or 2020). It remains to be seen whether these measures are truly effective.
In our view, the true risk lies in the decision by the U.S. to slap excessive duties on $540 billion worth of Chinese imports. Admittedly, the systematic transfer of American technology to China and the constant subsidies granted to state-owned companies in China need to be offset. But China’s boycott of major American tech firms has consequences: China is applying pressure to agriculture and petroleum sectors in the U.S. by importing soy from Brazil and oil from Russia instead!
The most important factor shaking up the world economy is the fact that the manufacturing sector no longer underpins global growth: 55% of China’s GDP is now generated by services.

In the U.S., employment is the key ingredient to a solid economy. As such, stable employment rates in the U.S. are essential to ensuring that the manufacturing slowdown does not spread to the rest of the economy.

It looks like the Euro zone has also been affected…

It definitely has. As we mentioned in the last quarter, industrial activity in Italy and Germany, for example, is subdued; services have not been affected, with the exception of the banking sector, which has been particularly hard hit in Europe. A recession is defined as a decrease in production over two consecutive quarters. Germany is close to this. Generally speaking, the creation of costly standards and increasing regulation weakens companies, all of which are subject to often monstrous competition.

In other words, are further QE (quantitative easing) measures still a possibility in Europe if needed? Is ammunition still available?

This isn’t a problem. The European Central Bank currently injects €20 billion into the economy every month. But as the Governor of the Banque de France, Mr Villeroy de Galhau recently pointed out, uncertainties bred by the current trade war and Brexit are blocking investment decisions by business leaders, which is of course detrimental to the economy.

A bit of inflation is often considered as the sign of a healthy economy. What is your view?

Perhaps, but no miracle cure exists. Inflation never spontaneously appears. Mario Draghi, who left the ECB last month after a brilliant mandate, saw that the significant increase in liquidities injected by central banks failed to produce the slightest sign of inflation; the opposite nearly happened.
A Democratic senator in the U.S. has suggested doubling the legal minimum wage!! This won’t happen any time soon, for a number of reasons. Only heavy investment in infrastructure, technology and the healthcare sector could kick start inflation.

Portfolio management: what is your opinion on the indisputable success of ETFs?

I understand why investors are attracted to inexpensive products involving low management fees. In the U.S., for example, 70% of ETFs are traded over-the-counter with no supervision by market authorities, even though they respectively represent 50% and 31% of all stocks and bonds traded.

We are instinctively wary of ETFs and only use them very occasionally in markets where we have not identified satisfactory funds.

Two highly reputed economists, Eugène Fama and Ken French,(American Century Investments, Federal Reserve Economic Data) consider that ETFs promise liquidity which their underlying assets cannot always deliver.

An article in the Swiss daily “Le Temps” on August 26 addressed the JP Morgan Global ETF study of the $1.1 trillion invested in these more or less liquid funds, which include bank loans, emerging debt, real estate, and more generally, high-yield debt. Similarly, Morgan Stanley notes that one-third of ETFs target instruments with illiquid underlying assets that rely on leveraging or swapping assets unrelated to the index in question: in August 2015, the NYSE suspended 327 ETFs on several occasions; ETF valuations shifted significantly from their underlyings, with discounts nearing 30% at times.
In the last ten years, investment banks – which used to supply liquidity in tough market times – have cut their stock holdings fivefold. Would this initiative be helpful in the event of a liquidity crisis?

In a complex economic environment, what type of investment would you recommend, either directly or via the funds in which you invest?

Despite our often cautious management approach, we have consistently steered clear of euro funds. Today, in a context of negative yields, insurers are dissuading savings account holders from investing in euro funds. The European Central Bank is achieving its goal to deter investors from this type of product and help companies.

On the long side, after investing in small and mid funds for several consecutive years – in Europe in particular – we’ve selected, since the beginning of this year, major, sustainably structured company stocks likely to generate robust growth while sidestepping market risk. Starting next year, we may re-invest in small and mids which have fallen behind.
From a tactical point of view, structured products let investors maintain worthwhile yields.

How should management firms and managers react?

Expanding your offer is a common sense approach we have defended for years: diversity, selecting transparent strategies, tangible assets, a focus on yields, hedge funds (though good ones are rare in the wake of 2008), and decorrelated investments in private equity.

To put it bluntly, are you pessimistic?

Certainly not by nature! The current state of politics is enough to cause serious concern. In financial terms, briefly, looking at the next five to ten years, emerging middle classes in Asia and especially China will play a role the importance of which we sometimes forget. Leaders of major international firms are perfectly aware of this.


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