June 2015
After moving quite steadily in one direction
since the end of January, the markets recently
entered a period of greater turbulence. Although the liquidity gates are wide open, key
equity and bond markets sustained corrections.
Thus we are reducing our risk exposure, at
least temporarily, and evaluating the potential
side effects of this unconventional monetary
policy.
Statistically, summer is the weakest season on the financial
markets, and this was evidenced punctually according to the
market adage: “Sell in May and go away.” After several decent months on the stock exchanges since the end of January,
various factors, such as the stalled negotiations with Greece,
worries concerning medium-term global economic developments and weakening technical indicators for the European
stock market, all stimulated profit-taking. Two factors raise
particular concern: the resumption of volatility per se, and the
simultaneity of the correction on stock and bond markets.
The latter threatens to impact even portfolios that are invested in various asset classes – and thus making use of the nat­
ural elements of diversification.
The stock market correction was accompanied by a significant increase in long-term yields on the largest and generally most liquid government bond markets, e.g. Bund futures,
which climbed from below 10 to over 70 basis points. An attempt to explain this surge in yields with merely fundamental
and technical factors – such as the recently heightened infla-
tion expectations in Europe or the closure of one-sided positions – would be too narrow a view. Rather, it is a manifestation of declining liquidity on the bond markets. The sweeping
securities purchase programme by the European Central
Bank (ECB) and consequent floods of cash into the markets
appear to be having a converse effect, at least in terms of
market liquidity.
What do these developments mean for investors? On the
one hand, the liquidity situation further erodes the opportunity-risk ratio for the bond markets, which are already suffering under record-low interest rates. On the other hand, cash
injections and the advantage of stock-market dividends provide solid support. Thus from a medium-term perspective,
there is no change in the status of shares as the more attractive asset class. At the same time, however, greater caution is
advisable, at least for the time being, due to the uncertainties
surrounding negotiations with Greece. Accordingly, we have
reduced our equity allocation to neutral.
Finally, investors should not overlook the less obvious
side effects of unconventional monetary policy nor the current geopolitical risks. The Notenstein lecture by Ernst
Baltensperger, an expert on monetary policy, suggested that
policy alone cannot cure all ills – indeed, it can even create
its own problems.
The summer months ahead will doubtless remain challenging, with the potential for very rapid change. In times
like these, it makes sense to rely on a solid, long-term investment strategy that incorporates various scenarios.
Fabian Dori
Head of Investment
Committee, Private Banking
–1–
Dr Silvan Schriber
Deputy Head of Investment
Committee, Private Banking
Notenstein Compass, June 2015
Bonds: trend reversal ahead for yields?
For months now, long-term government bond yields have
been on a steady southward course. However, the bond markets changed tack to an unfamiliar direction in mid-April:
yields are now rising. Yields on 10-year German Bunds
climbed from below 10 to over 70 basis points within a few
days, while the market yield on 10-year Swiss Confederation
bonds left negative territory and is now hovering around the
zero line. What looked like a change in yield of just a few
basis points translated into losses ranging from three to five
percent for bondholders in this maturity segment. At the
same time, there was a correction of about the same scale on
major European equity markets.
Although these sharp price movements were sudden and
unexpected, they should not be viewed as inexplicable exaggerations. We see them rather as part of a long overdue normalisation of yield levels, which also entails heightened volatility on the fixed-income markets. Yields had fallen to levels
that were unjustifiably low in fundamental terms, particularly due to high expectations surrounding the ECB’s current
securities purchase programme (QE) – levels which factored
in neither inflation nor growth, nor any other kind of risk
premium. At the same time, higher long-term interest rates –
at least higher than “zero to negative” – are certainly justified. On the one hand, inflation expectations have risen considerably since January, in step with the recovery in oil prices. On the other, the European economy is regaining its
footing to the extent that the European Commission raised
its growth projections for the eurozone and now forecasts
1.5 percent growth for the current year.
Trend reversal or normalisation?
Overdue correction on the bond markets
10-year government bond yields in %
4
3
2
1
0
–1
2011
2012
USA
Source: Bloomberg
2013
Germany
2014
Switzerland
2015
Although the fundamental basis for higher interest rates has
existed for some time, the intensity of the yield increase, and
of the inverse bond sell-off, was surprising. Factors contributing to the sharp reaction included the one-sided positioning
of many market participants and decreasing liquidity on the
bond markets. The latter issue will continue to represent a
serious risk in the near future; in addition to the poor opportunity-risk ratio, it is a further negative factor for the bond
asset class.
Commodity currencies: further potential for corrections
For the bond markets, however, the pivotal question appears to be not “Why?” but “What now?” Even at the present slightly higher yield level, bonds remain very expensive. Higher yields and lower prices would be fundamentally justified, but a combination of the ECB’s massive QE
programme and uncertainties regarding inflation and growth
momentum in industrialised countries makes for a heavy
counterweight which is likely to limit the extent of any further yield increase. Thus we expect yields to trend sideways in the near future, under conditions of sustained high
volatility.
Evidence of sharp corrections has also been observed beyond the bond and stock markets in recent weeks. A lengthy
trend on the currency markets has sputtered (at least intermittently): the US dollar is taking a break in its upward advance, as we have forecast in earlier issues. Likewise, the US
economy decelerated slightly by –0.7 percent in the first quarter. Ongoing weak macro data and the increasingly probable
postponement of the interest-rate trend reversal into next
year are the main factors weighing on the US currency. Des­
pite the current consolidation phase, USD rates are expected
to resume their upward trajectory in the 12 months ahead,
particularly against commodity currencies such as the Australian and Canadian dollars. Although these two alternative currencies have lost considerable ground over the last three
years, they are still relatively highly valued according to several valuation models. Various central-bank representatives
from these commodity-exporting countries followed the same
line: with their economies softening in the aftermath of the
commodity boom, interest rates are likely to stay low – or, as
was the case in Australia in early April, be lowered even further – for the foreseeable future. This, along with the level of
interest income attainable, reduces the appeal of these
long-favoured diversification currencies.
Commodity currencies not only have room to depreciate further against the US dollar; there is also potential for
–2–
Notenstein Compass, June 2015
setbacks vis-à-vis the euro and Swiss franc. In our tactical
investment policy we have thus adjusted our allocation of
US dollar alternatives to neutral.
As commodities trace out a floor…
…commodity currencies have room to depreciate further
Commodity currencies and Bloomberg Commodity Index, indexed per 1.1.2007
160
140
120
100
80
60
2007
2008
2009
AUD/USD
BB Commodity Index
2010
2011
2012
2013
2014
2015
ated with the transition to a new Chinese economic model.
China’s central bank has been tinkering with the monetary
screws for several months, and has managed to keep shortterm market rates well under control. The third reduction
in the policy rate since autumn 2014, carried out in early May,
fits into this picture. Such stimulus is clearly positive for the
equity market. As long as the market, which remains substantially driven by small investors, continues to enjoy government backing, the uptrend in Chinese shares should
persist. The renminbi has been surprisingly stable during this
phase. It is quite possible that China, considering the potential inclusion of the renminbi into the International Monetary Fund’s Special Drawing Rights – a virtual currency
based on a basket of other currencies – is purposefully refraining from pulling this third potential acceleration lever
for the time being.
China’s fear of a hard landing
Accommodative monetary policy supports economy and stimulates equities
CAD/USD
NZD/USD
Source: Bloomberg
China: on track for monetary policy easing
On the subject of commodities, after a decline extending over
four years, prices are now approaching a floor that should
hold for the medium term. This makes sense from a statistical
viewpoint at least, since a fifth consecutive year of falling
commodity prices would be a novelty not seen in the last 70
years. A fundamental perspective also supports stabilisation,
at the least: at these lower price levels, supply and demand for
many agricultural commodities are gradually approaching
equilibrium. Crude oil prices are likewise seeking renewed
equilibrium; after rallying by a good 50 percent in just three
months, the price is exploring the upper limit of a new trading
range. Meanwhile, there is evidence of a clearer stabilisation
trend in precious metals.
To consider industrial metals, we must look towards
China, where economic expansion of seven percent in the
first quarter was the slowest pace recorded in 15 years. The
government is adopting increasingly strong measures against
further economic softening. For example, infrastructure projects worth billions are very likely to boost demand for industrial metals. Similarly, the Asian Infrastructure Investment Bank (AIIB), founded under Chinese leadership and
slated to begin operations towards the end of this year, will
fund numerous major projects throughout Asia that will
drive demand.
Besides fiscal policy, monetary policy remains the second control lever with which to ease the growth dip associ-
MSCI China, 1-year interest rate and SHIBOR
140
7%
130
6%
120
5%
110
4%
100
3%
90
2%
80
01/2014
1%
05/2014
09/2014
MSCI China, indexed (left scale)
SHIBOR (right scale)
Source: Bloomberg
–3–
01/2015
05/2015
1-year interest rate (right scale)
Notenstein Compass, June 2015
A look sideways
Notenstein Private Bank regularly organises events on current issues in economics, politics and society. Our objective is
to encourage dialogue with leading figures and to learn from
their insights. In this way, we can offer our bank’s clients and
friends a basis for independent discourse, while at the same
time gaining knowledge and inspiration that we can integrate
into our daily business. We recently hosted two such events:
the fifth in a series of Notenstein Lectures in Lucerne, this
time with Professor Ernst Baltensperger, on the topic of monetary policy; and an address by former NATO Secretary General Anders Fogh Rasmussen on the current geopolitical situation, as part of the Notenstein Academy series in Zurich. We
are pleased to share with you the key points from these two
events.
Professor Ernst Baltensperger: “Monetary policy in times
of crisis”
Professor emeritus of Economics Ernst Baltensperger, named
“Mr Monetary Policy” by the press, addressed the consequences of the European Central Bank’s expansive monetary
policy. In his view, the ECB’s liquidity programme represents
an attempt to mitigate the eurozone’s structural problems and
foster growth. In the past, such experiments have been temporarily successful, but virtually always followed by negative
consequences, often via inflation, which represents the greatest risks, according to Professor Baltensperger, and not deflation. In general, monetary policy has been subject to unrealistic expectations – it cannot precisely control inflation nor the
economy, let alone resolve structural problems and hindrances to growth. In this light, the SNB’s abolishment of the EUR/
CHF floor was a determined response to the renewed flood of
liquidity. However, a return to normal conditions is dependent
upon an exit from zero-interest policies, especially by the US
Federal Reserve. Should this fail to materialise, Switzerland
could no longer rule out alternatives from the monetary policy poison cabinet, such as extending the negative interest rate
regime or introducing foreign exchange controls. Professor
Baltensperger expects that the normalisation process will un-
fold and that the dollar will thus remain strong against the
franc for the foreseeable future, while the euro softens. Nonetheless, he emphasises that a return to normal monetary policy is also a challenge that will likely provoke great political
and economic resistance. By the time these issues are resolved, it may be too late to efficiently siphon the excess liquidity from the economy.
Anders Fogh Rasmussen: “The future balance of power:
is the cold war back?”
The former Prime Minister of Denmark and former Secretary
General of NATO commented on global balances of power,
with emphasis on the Ukraine conflict, the Middle East and
the enormous population growth and rising significance of
Asia. Along these lines he mentioned Europe’s passivity, which
has resulted in the USA increasingly orienting itself towards
Asia, even seeking strategic alliances with China. Data on
arms spending reveals a widening gap between the West and
countries such as China and, especially, Russia, which reports
a sharp increase in military spending. This divergence requires
attention, and after Russia’s annexation of Crimea, several
NATO countries indeed began to increase their defence spending. While Mr Rasmussen believes the ties to Russia are still
significant, he nonetheless advocates rapprochement. History
teaches that it is imperative to integrate the former czardom,
yet recent attempts have failed, at least for the time being.
Should the Ukraine conflict escalate, the confrontation could
lead to a new form of cold war. Nonetheless, Mr Rasmussen is
not as pessimistic as some other observers about the future of
the NATO pact. The USA would retain its position as global
leader and continue to play a key role in strategic decisions.
Imprint
Issue Notenstein Compass, June 2015 Published by Notenstein Private Bank Ltd, Bohl 17, PO Box, CH-9004 St. Gallen, info@notenstein.ch, www.notenstein.ch
Editors Oliver Hackel, Head of Macro & TAA; Sandra Schlatter, COO Office Investment House Customer service We welcome responses and orders for all our
publications, either on www.notenstein.ch/contacts or by mail. The Notenstein Compass is published every two months together with Notenstein Dialogue,
in which Notenstein experts discuss key economic and social issues with a leading figure from business or academia. Our bank also publishes the White Paper series and Fokus Asien, which offers in-depth background information on developments in Asia five times a year (available in German, French and Italian).
Legal notice The material in this publication is provided for information purposes only and in particular, it does not constitute a simplified prospectus under the
terms of Art. 5, para. 2 CISA. You are welcome to call us with your enquiries at +41 (0)71 242 53 53. ISSN 2235-8323
–4–