Quarterly Investment Strategy
Mid-year review: so far, so good
Halfway into the year, let us pause to reflect on the global economic and financial situation. The good news is that many of the risks outlined in our 2017 outlook have abated, buttressing our view that a worldwide recession is not on the horizon. Rather, our favourite economic indicators point to continued and relatively broad-based expansion. But we must also acknowledge that a number of these indicators have begun to level off, suggesting some maturing of the cyclical upturn – at just the time when central banks are shifting away from crisis-management mode.
A slow but steady global growth environment, with limited inflationary pressures, has enabled central banks to maintain very accommodative liquidity conditions for a number of years. As the recovery endures and broadens – extending now even to the Eurozone and Japan – central banks are beginning to take or at least consider tightening measures. Albeit still positive, growth in global liquidity, defined as the combined balance sheets of the Federal Reserve (Fed), European Central Bank (ECB), Bank of Japan (BoJ) and People’s Bank of China (PBoC), thus looks set to slow down next year.
This is not to say that credit to the real economy will slump. After all, central bank liquidity injections were aimed first and foremost at preserving the financial system – not promoting growth and employment. The US is a case in point: while Fed money was the main driver of aggregate monetary growth between 2009 and 2014, there has since been a shift to commercial bank money, which in turn enabled liquidity to migrate from the financial to the industrial sector. The recent drop in US commercial and industrial loans did admittedly come as a surprise, particularly in light of strong business confidence, but it could be partly attributable to energy companies having regained access to the bond market, hence needing to rely less on bank loans than during the oil price slump.
In the Eurozone and Japan, credit trends have been steady to stronger, with surveys of bank lending confirming the improvement. There too, with a lag of few years relative to the US, commercial banks are taking over from the central bank in driving money growth.
Credit-ridden China is the relative exception to this brighter lending picture. Loan growth has been easing for over a year now, held back by a number of government measures: higher short-term rates, restrictions on shadow lending and housing curbs (impacting mortgage lending). But given policymakers’ intent to maintain ambitious growth targets, we do not believe that fears of a collapse in Chinese credit are warranted.
How about evidence that more expansionist fiscal policies will also help offset the shift in central banks’ stance? While most advanced economies should indeed see modest fiscal easing over the next two years, the detailed picture on this front too is mixed, with fiscal paths set to vary substantially by country. Little incremental fiscal tightening is to be expected in the Eurozone. The UK should slow its pace of fiscal consolidation, as Brexit starts to bite into economic growth. In the US, we expect Congress to eventually lower corporate taxes, although the size of the cuts will fall short of what the President has suggested. Driving the compromise will be the fact that both Congress and the Trump administration need a political success ahead of the mid-term elections. Ironically, fiscal stimulus is coming to the US just as the economy has reached full employment. Finally, China is making a structural transition to large budget deficits. Policymakers’ desire to rein in credit growth will only add to the impetus to find new sources of aggregate demand.
All told, the “soft goldilocks” environment that has propelled financial markets ever higher remains very much in place. Neither an inflationary drift nor a recession seem likely scenarios for the near future, warranting a continued risk-taking stance in portfolios. Elevated equity valuations are, however, a cause for concern, particularly in the US. We prefer to focus on regions where the economic cycle is less advanced, hence liable to boast greater earnings stamina. Emerging markets and the Eurozone thus remain our favoured regions – the latter also standing to benefit from dissipated political risks and a near climax in Fed-ECB monetary policy divergence, which should strengthen the prospects for the single currency.
Note: Unless otherwise stated, all data mentioned in this publication is based on the following sources: Datastream, Bloomberg, Lombard Odier calculation.
This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier. Accordingly, it has not been in accordance with the Swiss Bankers Association Directives on the Independence of Financial Research or any other legal requirements designed to promote the independence of investment research. Any information contained in this document is not and should not be regarded as financial research for the purposes of the Swiss Bankers Association or any relevant regulatory body. Consequently, this document is not subject to any restriction on dealing head of the dissemination of investment research. Furthermore it is duly stressed that opinions expressed in this document may differ from the opinions expressed by other divisions of Lombard Odier, including its Financial Research Department. This document is provided for information purposes only. It does not constitute an offer or a recommendation to subscribe to, purchase, sell or hold any security or financial instrument.
It contains the opinions of Lombard Odier, as at the date of issue. These opinions and the information contained herein do not take into account an individual’s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes a personal recommendation to any investor. Each investor must make his/her own independent decisions regarding any securities or financial instruments mentioned herein. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Lombard Odier does not provide tax advice. Therefore you must verify the above and all other information provided in the document or otherwise review it with your external tax advisors.
Investments are subject to a variety of risks. Before entering into any transaction, an investor should consult his/her investment advisor and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. The information and analysis contained herein are based on sources considered to be reliable. However, Lombard Odier does not guarantee the timeliness, accuracy, or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices, market valuations and calculations indicated herein may change without notice.
Past performance is no guarantee of current or future returns, and the investor may receive back less than he/she invested. The investments mentioned in this document may carry risks that are difficult to quantify and integrate into an investment assessment. In general, products such as equities, bonds, securities lending, forex, or money market instruments bear risks, which are higher in the case of derivative, structured, and private equity products; these are aimed solely at investors who are able to understand their nature and characteristics and to bear their associated risks. On request, Lombard Odier will be pleased to provide investors with more detailed information concerning risks associated with given instruments.
The value of any investment in a currency other than the base currency of a portfolio is subject to the foreign exchange rates. These rates may fluctuate and adversely affect the value of the investment when it is realised and converted back into the investor’s base currency. The liquidity of an investment is subject to supply and demand. Some products may not have a well-established secondary market or in extreme market conditions may be difficult to value, resulting in price volatility and making it difficult to obtain a price to dispose of the asset.
If opinions from financial analysts are contained herein, such analysts attest that all of the opinions expressed accurately reflect their personal views about any given instruments. In order to ensure their independence, financial analysts are expressly prohibited from owning any securities that belong to the research universe they cover. Lombard Odier may hold positions in securities as referred to in this document for and on behalf of its clients and/or such securities may be included in the portfolios of investment funds as managed by Lombard Odier or affiliated Group companies.
European Union Members: This document has been approved for use by Lombard Odier (Europe) S.A., a credit institution authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg and by each of its branches operating in the following territories: Belgium: Lombard Odier (Europe) S.A. Luxembourg • Belgium branch, a credit institution supervised in Belgium by the Banque nationale de Belgique (BNB) and the Financial Services and Markets Authority (FSMA); France: Lombard Odier (Europe) S.A.• Succursale en France, a credit institution supervised in France by the Autorité de contrôle prudentiel et de résolution (ACPR) and by the Autorité des marchés financiers (AMF) in respect of its investment services activities; Italy: Lombard Odier (Europe) S.A. • Italian Branch, credit institution governed in Italy by the Italian stock market regulator (Commissione Nazionale per la Società e la Borsa , or CONSOB) and the Bank of Italy; Netherlands: Lombard Odier (Europe) S.A. • Netherlands Branch, a credit institution supervised in the Netherlands by De Nederlandsche Bank (DNB) and by Autoriteit Financiële Markten (AFM); Spain: Lombard Odier (Europe) S.A. • Sucursal en España, a credit institution supervised in Spain by the Banco de España and the Comisión Nacional del Mercado de Valores (CNMV); and United Kingdom: Lombard Odier (Europe) S.A. • UK Branch, a credit institution in the UKsubject to limited regulation in the UK by the Financial Conduct Authority (‘FCA’) and the Prudential Regulation Authority (‘PRA’). Details of the extent of our authorisation and regulation by the PRA and regulation by the FCA are available from us on request. UK regulation for the protection of retail clients in the UK and the compensation available under the UK Financial Services Compensation Scheme does not apply in respect of any investment or services provided by an overseas person.
In addition, this document has also been approved for use by the following entities domiciled within the European Union: Gibraltar: Lombard Odier & Cie (Gibraltar) Limited, a firm which is authorised and regulated by the Financial Services Commission, Gibraltar (FSC) to conduct banking and investment services business; Spain: Lombard Odier Gestión (España) S.G.I.I.C., S.A.U., an investment management Company authorised and regulated by the Comisión Nacional del Mercado de Valores (CNMV).
Switzerland: This document has been approved for issue in Switzerland by Bank Lombard Odier & Co Ltd Geneva, a bank and securities dealer authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA).
United States: Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term “United States Person” shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
This document may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Lombard Odier.