Investment Outlook 03.2017
Thomas TrauthEconomist, Dr. rer. pol., CFA, FRM
The goldilock environment continues
Market sentiment continued to improve in February. We observed a broad-based rally of risky assets. Emerging markets rose 8.6% between the beginning of the year and the end of February. Strongest performers have been India (8.5%), Brazil (10.7%) and also Mexico (6.5%), while the Russian equity market fell by 8.8%. Equity markets in Asia Pacific enjoyed a strong rally as well. In particular, the Hang Seng rose 11.7%. The US equity market continued to outperform other developed equity markets. The S&P500 index climbed 5.6%, followed by the MSCI Europe with 2.2%, and the Japanese Nikkei 225, which was flat. The equity volatility index, VIX, which measures the price of insurance against a fall of the S&P50 index, remained at historically low levels around 11. This could very well indicate a certain degree of complacency among investors.
Also bond markets rallied in February. US 10-year government bond yields declined 6 basis points and German Bund yields even 23 basis points. As a result, the US-European yield spread widened further to about 200 basis points. Also, credit spreads continued to tighten in February, both for high yield and emerging market bonds.
The European PMI climbed further to 55.4 after 55.2. Output growth was driven by the manufacturing sector with strong new orders and new export business.
The US PMI rose as high as 57.7 in February after 56.0. The US non-farm payrolls for February rose 235,000 after 238,000 and signal continued job creation.
Headline inflation in the US rose to 2.7% year-on-year and to 2.0% in the Eurozone. US inflation expectations, as measured by 10-year break-even rates stabilized around 2.0%, while the European inflation expectations fell slightly to a level of 1.25%.
As expected, on 15 March US Fed decided to raise the Federal Funds Target by 25 basis points to be within 0.75% and 1.00%. The Fed sees risks as balanced and the general policy stance as still accommodative. The comments by Fed chairwoman Janet Yellen suggest that two more rate hikes can be expected this year.
Meanwhile the ECB, on 9 March, kept rates unchanged. ECB’s chairman, Mario Draghi, however, made clear that further stimulus measures have become less likely. While the ECB seems to be committed to maintain its QE program for longer, there is a sense that the ECB may announce first steps to exit its ultra-accommodative policy stance during the course of the year.
Better growth, strong earnings and still accommodative central banks, keep us positive on risky assets. Especially because, in addition, government bonds, particularly in Europe, remain highly unattractive.
We kept our high-yield bond allocation unchanged, despite somewhat stretched valuations.
The yield differential between US and European short-term rates is about 200 basis points and may increase even further. Therefore, being short, the USD is very expensive and we expect the USD to remain on the strong side.