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Quarterly Market Update

Political risks and central banks dominated the third quarter. The month of July was relatively quiet on the political news front. However, August and September saw renewed geopolitical tensions between the US and the rest of the world. The Trump administration announced its plan for a 25% tariff on USD 200 bn additional imported goods from China, raising uncertainties once again over retaliation measures. Additionally, a deteriorating situation in Turkey, as well as concerns over Italy’s finance after the government set a wider-than-anticipated budget deficit, put pressure on the euro against the US dollar. Over the quarter, the EUR/USD came down as low as 1.1302, before recovering somewhat. At the end of the quarter, the euro was worth USD 1.1605.

 

On the monetary policy front the European Central Bank (ECB) left its benchmark interest unchanged and maintained its will to end its bond-purchase program by the end of the year. No interest rate increase should occur before next summer. Mario Draghi expects higher inflation driven by higher wages. The European expansion is still solid and the ECB foresees 2018 GDP growth to be 2% and 1.8% next year.

During the summer, the Bank of England (BoE) increased the benchmark interest rate by 0.25% to 0.75%, which was largely anticipated. As Brexit is closing in, economists do not expect any rates hike before next March.

In September, the most interesting announcement came from the US Federal Reserve (the Fed), which increased the interest rate by 0.25% to a 2-2.25% target, setting the highest level since mid-2008. In his speech, Fed Chairman Powell removed the word “accommodative”. This means that interest rate hikes are closer to the end than the beginning. Mr. Powell also mentioned a strong economy, citing job growth, household spending and business fixed investments. He also prepared the market for another rate increase this year, probably during the December meeting. Economists anticipate two additional increases next year.

 

Despite the ongoing negative rhetoric on tariffs, the equity market did reasonably well during the quarter driven by solid macroeconomic fundamentals and good corporate earnings, but we witnessed large discrepancies between some markets as well. Globally, equities gained 4.8% driven by the US market.

Indeed the S&P 500 index increased 7.2% to reach a level of 2’913.98 (+8% YTD) over the quarter. The Nikkei 225 index and Brazil’s Bovespa index followed a similar pattern. European stock markets were generally muted over this quarter. The Euro Stoxx 50 index managed to post a minor gain (+0.6% in 3Q) despite a 4.7% drop in Italy’s MIB index. However, European stocks remain in negative territory with a 2.6%-decline since the start of the year. On the negative side, the FTSE UK index declined 1.8% (-2.5% YTD) due to concerns over Brexit and the failure of Mrs. May to satisfy all parties with a plan. Ongoing concerns over trade tariffs pressured Chinese equities too, with the CSI 300 index losing 2.05% (-15.9% YTD).

 

Looking forward, the US mid-term elections in November may lead to a pause in the aggressive wording of President Trump with regard to tariffs. Thus, and because of good fundamentals, we continue to be constructive toward equities, slightly overweighting them in the portfolios. The US is our favourite market overall, though valuations of European stocks should not be ignored either, all else being equal.

 

In the third quarter the worst performing asset was gold, which lost 4.9%. This confirms our opinion on good fundamentals supporting equities, as investors did not seek a safe haven by purchasing gold.

Oil was on an uptrend, rising 4.8% during the quarter. The Brent reached USD 83.03 a barrel at end of September because of lower production rates in the Middle East.

 

As far as yields are concerned, they remained desperately low in Europe. The German 10-year yield continues to hover between 0.4% and 0.5%. Given the latest comments from the ECB, we believe probabilities are tilted to the upside as we do not see the yield going much lower, all else being equal, though it will be very gradual and slow.

As the Fed increased its benchmark interest rate, the US 10-year breached through the 3% threshold to trade at 3.07% as we write these lines.

 

On the fixed income side, we maintain our neutral stance with a negative bias. Low yield in Europe and rising interest rates in the USD lead us to believe that there is no urgency to increase the exposure at the moment. Once the market will be convinced that the Fed is close to stopping raising rates, we may become more positive on this market. For the time being, we continue to favour debts with short maturities or with variable coupons.

 

This large differential in interest rates between Europe and the US is another reason behind the appreciation of the USD vs. the euro. During the quarter, the greenback continued to appreciate (+0.7%), although at a much slower pace than in the second quarter. Uncertainties with regards to Brexit also led the British pound to weaken against the USD. The GBP/USD exchange rate stands at 1.3038, down 1.28% since end of June, but traded as low as 1.2691 in mid-August.

 

Unless the concerns over a full blow from Italy on the Eurozone re-surface, we believe the euro will stabilize in the coming months vs. the US dollar before re-appreciating again. There is a wide differential in interest rates between the euro and the US dollar currently, but as previously mentioned the Fed should stop increase rates sooner rather than later, which may coincide with the ECB increasing rates next summer. Hence, once the market anticipates one of these moves, the euro will change course in our opinion. Finally, the GBP will remain linked to the news flow related to Brexit. Volatility will remain and as the BoE should not do anything on interest rates until the March deadline, we believe the GBP will go nowhere until then.

 

 

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04.10.2018