«If you ignore the negatives, you cannot achieve anything positive.»
(Erhard Blanck, German naturopath, author and painter)
Central banks have been trying in vain to combat the threat of deflation, stimulate the flagging economy and weaken their domestic currencies, leaving a raft of new measures in their wake. At the end of January, the Bank of Japan (BoJ) introduced negative interest rates and began imposing penalty interest on the deposits it holds. And it is in good company: Switzerland, Denmark, Sweden and the eurozone have also adopted negative interest rate policies (NIRP). The new mantra appears to be «the more negative, the better».
The NIRP group may soon have another new member too – Norway’s central bank slashed its base rate to an all-time low of 0.5% in mid-March, while announcing a possible further rate cut later in the year and refusing to rule out the introduction of a negative interest rate policy.
The trend toward ever lower interest rates has been welcomed by investors over the years. However, in the first trading days of the new year, they were forced to accept that nothing positive can come from too much negativity – at least not in the economy, and especially not on the stock markets. Equities were promptly offloaded, with bonds and precious metals in particular delivering strong returns in the first quarter of 2016 (gold +16%, silver +11%).
The recovery kicked in after the upheaval on the commodities markets had subsided and the price of crude oil began to recover in mid-February: The price of European Brent Crude climbed by 15% in March, offsetting the losses in January (9%) and February (3%).
The equity markets, however, saw mixed results. Thanks to flat performances in the US and UK stock markets, the dollar-denominated MSCI World Index ended the first quarter almost unchanged. The stock markets in mainland Europe and Asia, however, were hit hard: Germany’s benchmark DAX index lost 7%, Swiss equities were down 9%, and Japanese equities plummeted 12% despite NIRP.
The absence of evidence is not the evidence of absence.The interest rate is an important factor in John Maynard Keynes’ consumption function. According to Mario Draghi, President of the European Central Bank (ECB), it is therefore obvious that low interest rates will stimulate consumption and, thus, economic growth – hence why he has no qualms about persevering with the NIRP experiment. However, for some time now, many top economists have been casting doubts on the general validity of this antiquated function and questioning whether it can even be applied in a negative-interest environment.
How strong would economic growth have been if the European Central Bank had not followed an expansive policy after the financial crisis? No one knows for sure, as it is impossible to say what the consequences of not taking any action would have been. Economic development in Europe can at best be described as lethargic with a positive undercurrent, but it is no secret that the main beneficiaries of the open cash floodgates on both sides of the Atlantic have been the financial markets.
However, the last three months have shown that the main investor-friendly measures are fizzling out and the markets are becoming jittery again. In light of this, it is hardly surprising that the various central banks are beginning to adopt a more risk-averse stance. After becoming net buyers of gold again in 2010 for the first time in more than 15 years, they acquired a record 588 tonnes of the precious metal last year.
|MSCI World Net USD
|Swiss Performance Index
|JPM GBI Global Traded TR USD
|Swiss Bond Index AAA-BBB TR
|Thomson Reuters/Jefferies CRB TR USD
|Real Estate Switzerland
|SXI Real Estate® TR CHF
|Exchange rate EUR/CHF
|Exchange rate USD/CHF
Our cautious forecast has proven to be correct since our last update in January. Equities were unable to benefit from the traditionally positive six-month period between November and April. Our indicators currently suggest that risk is becoming less concentrated, meaning that the observed seasonal anomaly (summer rally rather than summer slump) could continue. In the medium-term, the less volatile risk situation after the healthy correction gives us some cause for optimism again. The likelihood of significant tail risk has diminished over the past few days, and the following arguments considered as a whole would justify increasing the proportion of real assets to a slightly underweight position compared to the benchmark.
- Our prospective risk indicators remained at a high level for quite some time. The unusually high concentration of risk sounded a note of caution. Our risk indicators have gradually fallen back again in recent weeks, which would indicate that risk conditions on the financial markets are becoming slightly more favorable.
- The sharp stock market correction at the start of the year – and the sustained recovery on the back of it – suggest that the outlook for the equity markets is becoming gradually brighter.
- Swiss banking clients have historically held a high proportion of equities in their mixed portfolios. Due to the upheaval at the end of the year, this position has now changed – albeit only slightly. Investors remain overinvested in equities.
- Despite the stock market correction at the beginning of the year, American investors continue to hold a record 2.5% of the equity market capitalization on margin. These purchases on credit tend to curb equity prices. Comparatively high levels were observed in 2000 (2.3%) and 2007 (2.1%).
- On June 23, 2016, Britain will hold a Brexit referendum to decide whether it will leave the EU. Strong fluctuations on the financial markets due to the uncertainty around whether or not the country will remain in the EU cannot be ruled out.
Global financial markets – review
(See previous table)
The first quarter of 2016 got off to a poor start. The considerable losses in the first few days and weeks were a sign of things to come: the first four days of January represented the worst trading period since records began, while January was the most miserable month for a long time on the world’s stock markets. Performance over the first three months as a whole, however, was not quite so bad. After several months of losses, emerging markets managed to record a gain of 6%. The dollar-quoted MSCI World Index clawed its way back into even territory, thanks to marginal gains in the UK and US. However, stock markets in the eurozone and the established Asian markets took a big hit. The MSCI Europe fell 7%, while the markets in Japan and Hong Kong were down 12% and 5% respectively. Swiss equities suffered the same fate, falling by 9%.
Most market players came to realize that bonds could actually become even more expensive despite historically low interest rates. At the start of the year, bonds were boosted considerably after a stock market exodus. In a surprise move at the end of January, the Bank of Japan then decided to introduce penalty interest of 0.1% on cash held at the BoJ by commercial banks. The increase of 7% in the first quarter helped the global bond index to a dollar-denominated annual return of 6%. With a gain of more than 2%, the strong first quarter of 2016 also ensured that Swiss bonds were up 2% for the 12-month period.
Commodities set the pace for equities in the first quarter. Mid-February marked the start of an upturn, spearheaded by the rally in oil prices. Although it was not enough for the overall index to finish the quarter in positive territory (–3%), investors in precious metals were among the biggest beneficiaries of the stock market upheaval: the price of gold increased by 16%, while silver was up 11%. Despite a rise of 2% for the quarter, Brent Crude was not able to record a gain for the full year due to heavy losses over the previous nine months. The price of Brent is still 20% lower than it was twelve months ago.
The real-estate sector only benefited to a limited degree from the weak stock markets. Although the quarterly results of the fund for real estate in Switzerland (+4%) and the index for American real-estate equities and funds (+1%) were positive, franc-denominated results over the last 12 months were a mere 0% and 3% respectively. The potential for further gains in the Swiss real-estate segment remains limited; at 28%, the premium (the amount paid over the net asset value) is almost twice as high as the long-term average of 15%.
It is looking increasingly likely that the US Federal Reserve will have to rethink its original plan to raise interest rates gradually over the course of this year. Global economic development is too heterogeneous, and the race by central banks to weaken their own currencies shows no signs of slowing. This realization has incited investors to sell the dollar, both against the euro (–5%) and the franc (–4%). The losses of the British pound against the franc were even greater (–6%), due to fears of a Brexit.