Interest rate cut
With economic growth slowing down globally, markets recovered from the May downturn. Principally as a result of the Fed and ECB’s actions – both promising interest rate cuts and other forms of fiscal stimulus – the good mood made a comeback. The words used by Draghi came close to his “whatever it takes” intervention in 2012. Back then it was to save the Euro. Now it was mainly meant to breath some life into growth and the waning inflation level.
Not because farmers, bakers and countrymen would be in need of lower interest rates. The positive effect was meant for markets in general and for internationally trading companies that are bearing the brunt of Trump’s trade war. However much we would like it, we can’t neglect our Donald in this crippling issue. In spite of his detrimental role in global trade, he might unintentionally have it his way when the Fed eventually lowers its rates going forward. And of course he will loudly let us know how important his role has been in the process.
Interest rate levels in the capital markets in both the US and Europe already reflect this likely fall in the Fed funds rate. Stock markets as well have anticipated and are equally assuming that Xi and Trump would become the best of friends again at the G20 in Osaka. We viewed this as a premature conclusion and have hence decided to start slightly underweighting equity positions. We achieved this by lowering our positions in Europe a bit. Year to date, these have done reasonably well. We also bid farewell to part of our hedge fund investments. We haven’t had too much joy from these investments which fortunately bounced back during the first half of the year.
Reality check
Time has come for a reality check on various issues: no, it isn’t China that’s paying the higher tariffs to the US, it’s the American citizens and companies that import products from China and buy them in their stores. They are the ones paying these extra taxes. And when products get more expensive, one can buy less of them. It is putting the brakes on economic growth, Donald. Entrepreneurs will not invest more when interest rates move from very low levels to ultra-low levels. They will only do so when the ‘coast is clear’ and unexpected surprises like a variety of tariffs, costs, prices, taxes will no longer interfere with their profitability. And even if Trump and Xi have introduced a pause in their trade conflict, the uncertainty for both internationally trading entrepreneurs and investors hasn’t diminished.
And on Brexit: if a reasonable though battered and indecisive PM gets replaced by an opportunistic windbag, prospects for the UK do not necessarily get better. Brexit as a news item has more or less disappeared. Likewise, the intensity by which the financial situation of Italy dominated the headlines, has diminished as well… How boring…
Recession?
In the meantime, economic growth is slowing down in most ‘open’ economies: based on a series of trade, production, order and forward looking data, the risks of a recession has increased, unfortunately. In Europe the worst data come from Italy and Germany, though the fall in order volumes seems to happen all over the eurozone and this is not a good sign. Growth levels in Emerging Markets are for some time now disappointing too. Should the US Dollar take a step back as a result of lower rates, it could be a stimulus for Emerging Markets, as many of their debts are US Dollar denominated.
At the same time, Germany and The Netherlands have become the Switzerland of the eurozone. But let us not pretend this to be a positive sign: instead of fleeing into the DM or the Guilder, German and Dutch government debt are forming an alternative escape route. Almost all German and Dutch government bonds are showing a negative yield.
Liquidity
We are probably going to miss part of the capital gain related to yields dropping further into negative territory. We prefer however to hold fixed income investments with a positive coupon, as there are our Private Debt investments in Euro, which we started with last month. We hope to achieve a yield of 4-5% per annum, after costs. These are illiquid investments that are unlikely to be marketable before their maturity. We trust that is clear.
During the past month, however, some unrest appeared at certain investment funds in London which were partly invested in illiquid products though pretending they were 100% liquid. When the truth came out, large numbers of investors tried to get their money back and that became a problem. In those cases, the result is often that a fund gets closed in order to prevent the remaining investors ending up with unsellable (but not worthless) securities.
We do have to realize that liquidity in financial markets has generally diminished after the previous financial crisis. The reason is the following: today, banks are required to hold much higher levels of capital to secure their trading activities. As a result, trading costs have risen for them which has led to much lower activity. They can no longer handle large trading volumes and if too many parties want only to sell (or buy in what are called ‘one way’ trades) it can lead to major price swings. And all this happens when we wanted to have ‘safer’ financial markets after 2008… The unintended side effects of regulations.
Food for thought
With the holiday season starting, I would like to give you a few questions to dwell over:
1. If mortgage rates would turn negative and the bank is paying you to finance your house, would you consider to borrow more to buy a bigger house?
2. Temperatures in large parts of Southern and Middle Europe are reaching 45C levels and French holiday entrepreneurs are buying campings and holiday parks in ……… The Netherlands. Who will buy your house in Spain, Italy or the South of France, eventually?
May I therefore wish you a refreshing summer holiday on the lovely coast of Spitsbergen. We are noticing a few bears on the road ahead, as you will have read, but we keep our eyes open, with some extra cash at hand.
BY: WOUTER WEIJAND, Chief Investment Officer
