Apologies again for the radio silence over the last few weeks. Endless events, more than a few board meetings and a research report to write. Back to normal service now.
Let’s be honest – 2019 has been something of a surprise. I like many I thought that this year would be the year the markets ‘turned’ in anticipation of the always impending slowdown. In reality, 2020 proved to be a fairly positive year for both equities and bonds. Major equity indices are up 15-25% year-to-date, an impressive move even after factoring in last December’s risk-off. Meanwhile, global bond yields are down sharply, despite a mild sell-off in recent months. Even better as we look forward to 2020, the economic outlook has improved. I stick with my view, off expressed on these pages, that the recent turbulence was another pause for breath in a long, seemingly relentless bull market, egged on by central bankers.
That said I think we need to be aware of some challenges as we head into the new year. By any definition, the US recovery is late-cycle and due a slowdown although the impending Presidential election complicates matters mightily.
The euro area still has enormous challenges as we discuss below, (with savings and negative interest rates) and China, crucially, seems to be trying to engineer a slower, more sustainable growth rate in the face of trade wars. I think analysts at Barclay’s sum it up very well when they suggest that “all of this makes for a rather unexciting macro outlook”.
In investment terms, stock markets seem fully priced, and much of the recent rally in equities seems due mainly to multiples expanding, not earnings growth. That last point – earnings – is crucial. For the bull market to run even stronger in 2020 we need to see some evidence of earnings growth, especially in the US. To date, the evidence for this has been patchy at best and until we see firm data on a bounce in corporate earnings, my sense is the current bull rally will struggle as it heads into 2020.
A savings glut
A few years back former US Federal bank chair Ben Bernanke advanced what seemed like a radical idea – the world was suffering from a savings glut. This was roundly ridiculed in some quarters; especially as global debt levels were also at the same time rising inexorably. But over a decade later, those words seem spookily prescient, at least as far as Europe as concerned.
While much of the European bond markets trades in negative-yielding territory evidence is mounting that European savers are responding by INCREASING their money hoard of spare cash and paper wealth.
According to Oliver Eichmann, Head Fixed Income Rates EMEA at DWS the Eurozone now runs a savings surplus of more than 300 billion euros per year. What makes this even more difficult as a policy challenge is that there is evidence that this mountain of savings is actually growing as a result of negative interest rates. The first chart below is from Pimco and shows that the household savings rate in many countries experiencing negative interest rates is growing over time. This poses a real dilemma for the European Central Bank. If negative interest rates don’t discourage increased savings, what’s the next weapon to increase consumption?
The flip side of this glut of savings is that Europe is also running a massive trade surplus. The second chart below shows the lockstep between negative yields. From this perspective, the question analysts at DWS observe “is not whether the ECB will hike rates again, but how to create an environment where the corporate sector is willing to invest, thus achieving a return, and passing on part of this return to creditors. That is something monetary policy cannot achieve on its own.” European savers and consumers need to find some confidence in their economies – and start spending. Equally European corporates also need to boost confidence and start investing in order to grow productivity.
If President Trump really wants to close that trade gap maybe he should be encouraging European’s to stop being frightened about spending those savings.