The biggest elections in history began on Thursday, April 11. They are taking place in India and will be held until May 19. Some 900 million Indians are called upon to choose the next government for this nation of 1.3 billion people, the most populous democracy in the world. These elections serve as a vote for or against the Conservative Prime Minister. Narendra Modi, 68, is running for a second five-year term with the Bharatiya Janata Party (BJP, Indian People’s Party).
While equity investor sentiment oscillates between, on the one hand, the euphoria of having the support of central bankers and their highly accommodating monetary policies and, on the other hand, the pessimism of a misguided global economic cycle combined with trade war and high valuation levels, there are independent investment themes. In a way that is far removed from these tricky issues, the US healthcare sector can outperform all the others (see Chart of the Week). The reasons are both structural and cyclical.
The profit season has begun, and it is usually a source of happiness for investors. Equities tend to fluctuate sharply after the release of earnings and this can be a lucrative opportunity. This time, many companies are beating expectations, helping to drive main indices to record levels. The most famous of them, the S&P 500 is approaching its historic high, where from 21 September 2018 it reached 2940.91 dollars (see chart 2). Hopes that it will break its psychological resistance, supporting the current bull market, is therefore high. On the other hand, for companies that published earnings below expectations, the punishment is more severe than usual.
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.