European banks have been under pressure for a decade. They will continue to underperform due to several structural factors, ranging from tougher legislation to financial technology competition (fintech). These factors are there to last, but
in the shorter term, two other important phenomena will weigh on the sector: the debt crisis in Italy and the extension of negative rates.
The extraordinary monetary policies implemented by central banks over the past 10 years have brought interest rates to extremely low levels for an extremely long time. In their quest for returns, investors around the world naturally turned to more profitable asset classes. Of course, these include equities, but also illiquid assets such as real estate and private equity. These days everyone invests in private equity funds, not only individuals or banks, but also big pension funds or sovereign funds. CalPERS, the famous California Public Employees’ Retirement System, has just announced its intention to increase its private equity investments in order to boost its returns. On the other hand, asset manager BlackRock explains that more than half of its clients now want to reduce their exposure to the stock markets and increase their exposure to private equity.
Stocks have recently moved closer to their historical peak, particularly in the United States (see chart 2) while VIX and SKEW indices dropped substantially (see Chart of the Week). As a reminder, the Chicago Board Options Exchange VIX
reflects a market estimate of implied volatilities and is also known as the “fear index”. It declined from 36.2 in December to 12.4 recently. For its part, the Skew indicator is a measure of relative demand for protection against large swings in major global equities. Levels greater/less than 0 indicate more/less stress than is normal. It decreased from 1.15 at the end of the year to -0.57 last week.
The number of indebted companies has risen sharply around the world. Between 2009 and 2018, companies borrowed an average of $1,800 billion per year on the markets. This is almost double the average annual level before 2009 (see
chart 2). As a result, the global outstanding debt in the form of corporate bonds issued by non-financial companies has reached its highest level: $12,950 billion (see chart 1). And this amount does not include loans negotiated with banks or
other public or private institutions.
In Europe, growth has slowed sharply since the beginning of 2018 and inflationary pressures are non-existent. Recently, the European Central Bank (ECB) took note of this difficult economic situation by drastically lowering its forecasts for
2019. It also decided to keep its key interest rates in negative territory for several quarters, to continue its monetary creation by buying bonds and to offer new credit lines to banks at their request. All these decisions are aimed at easing
the monetary policy of the Euro Area (see Weekly Investment Focus of March 11, 2019). The ECB could go even further, by implementing a second Quantitative Easing (QE2), if the slowdown were more severe than expected or if deflation
risks became prevalent.
The latest economic publications from the Old World confirm the slowdown in activity. Gross Domestic Product (GDP) grew by 0.1% and 0.2% in the third and fourth quarters of 2018, a sharp decline compared to previous quarters. Annual
GDP growth has thus risen from 2.8% to 1.1% since its previous peak (see chart 2). The outlook for the next quarters is poor. In previous publications, we have detailed the marked decline in leading indicators: PMIs, IFO, confidence indices compiled by the European Commission, etc. Investors are confirming this expectation, believing that growth will continue to weaken (see chart 3).
The United States is the last bastion where economic activity is growing vigorously, at an annual rate of 3%. The American giant will publish its Gross Domestic Product (GDP) for the fourth quarter of 2018 on Thursday, February 28. It is expected to increase by 2.5% compared to the previous annualized quarter. A figure below this level, as we expect, would be negatively perceived by investors, reflecting recent economic signals received from both sides of the globe. Indeed, global growth is slowing down in an increasingly visible way. The Baltic Dry Index, which provides an average estimate of tariffs on 20 bulk dry cargo routes (ores, coal, metals, cereals, etc.), has reached its lowest level in two and a
half years (see chart 2). It is a sign that world trade is slowing down in a cyclical way, regardless of the outcome of discussions between Washington and Beijing about their trade war. This message is corroborated by the increasingly
rapidly deteriorating order books (see chart 3). The rate of contraction in the goods-producing sector is expected to worsen in the coming months.
The fourth-quarter earnings season is slowly tapering off, and performing better than expected. Two-thirds of the S&P500 companies have reported, and about 71% of them have topped expectations. The average earnings growth rate
year-on-year for the fourth quarter is 14% (see chart 2), beating expectations of 11%, which was revised downward from 12% in early December. This picture is encouraging and justifies the significant rebound in stock markets over the past
month and a half.
The majority of investors expected the volume of money in the global financial system to decline this year. This anticipation of a tightening of monetary policies by the world’s major central banks has been modified. The high point of this reversal of perception came from the recent speech of the American Federal Reserve (see previous Weekly Investment Focus). After selling part of the government bonds it held in its balance sheet at a sustained pace, the Fed now wants to reduce outstanding liquidity much less quickly. Similarly, the European Central Bank, which has stopped buying bonds, is considering which tool it will use to support its convalescent banking system. As for the Bank of Japan,
the economic situation in the archipelago is so fragile, it has not even had time to consider tightening its monetary policy. It will continue to contribute to the inflow of new money into the financial system through the purchase of government
Future on Dividends ▪ European companies try to safeguard the payment of their dividends ▪ Typically, dividend futures trade at a discount of their estimated fair value ▪ This implies that there is an opportunity to capture a premium ▪ The timing of the entry point remains predominant AFG-Future-Dividends-en