Outlook for the capital markets: a bet on monetary policy

Jens Wilhelm

Jens Wilhelm has been a member of the Executive Board of Union Asset Management Holding AG since 2008. As Chief Investment Officer, he is responsible for portfolio management, the real-estate funds business and the IT infrastructure segment.

The first half of 2019 was upbeat for the capital markets, following a difficult trading year in 2018. Jens Wilhelm, member of the Board of Managing Directors of Union Investment responsible for portfolio management, gives us his predictions for the second half of the year.

Mr Wilhelm, the first half of the year was upbeat for the stock markets. Are you expecting more of the same?

Not to the same extent. There were hopes that economic growth might pick up momentum and that the trade dispute might ease overall, but neither has come to pass so far. The central banks have responded logically and shifted back towards more expansionary monetary policy, which has really helped the stock markets. This support will continue to have an effect in the second half of the year. At the same time, however, the economy is ailing and geopolitical tensions remain high. Which will have the greater influence? That will be the key question for the remainder of the year.

You mentioned the weak economy. What are you expecting in terms of growth?

Growth is expected to slow in almost every major economic region of the world. For the US, we are still forecasting GDP growth of 2.7 per cent for 2019, but in 2020 it will drop to 1.7 per cent. This is going to substantially slow down global economic growth and weigh on the eurozone too. Both in 2019 and in 2020, the euro area’s economy is set to expand at a rate of just 1 per cent, with Germany’s rate of growth even lower still.

Weaker growth, but no recession

Projected decline in growth in 2019 and 2020 (GDP forecasts)
Projected decline in growth in 2019 and 2020 (GDP forecasts)
Sources: Union Investment, Thomson Reuters Datastream, as at 23 July 2019.

What is causing this slowdown?

In the US, it’s undoubtedly the waning effects of Trump’s tax reform. But economic growth is also increasingly being hampered by the US-China trade dispute. Don’t forget that the dispute is essentially a reflection of the power struggle between two global superpowers. This is about much more than just tariffs. Sadly, further escalation cannot be ruled out. And concerns about this prospect are already influencing many business decisions and putting a strain on global trade, which is expected to grow by only 1.5 per cent in 2019. This takes an important growth accelerator out of the equation for export-oriented economies such as Germany.

How will the central banks respond to this development?

The central banks have already started to change tack. Interest-rate hikes are off the table for the next two years. In fact, things are heading in the opposite direction. The Fed actually lowered interest rates at its July meeting and a further reduction could follow later this year.

What will the European Central Bank (ECB) do?

It will also loosen the reins. We expect that the entire interest-rate corridor will be lowered by 25 basis points by September at the latest. Exempting commercial banks from penalty rates up to a certain threshold - following the example of the Swiss National Bank - also looks likely, followed by the announcement of a new bond-buying programme.

What does this mean for investments?

Low interest rates are here to stay, and they’re not expected to rise any time soon. Our yield forecast for ten-year Bunds, for example, stands at minus 0.4 per cent at the end of the year. This yield level is likely to remain relatively unchanged until mid-2020. Interest rates will therefore languish deep in negative territory. Conditions in the eurozone are now strongly reminiscent of Japan.

Interest rates in the US are higher. Does the picture look different there?

The level might be higher, but the direction is the same. We expect yields to continue falling in the US as well. Yields on ten-year US Treasuries, for example, are expected to drop to 1.9 per cent by the end of 2019.

Is it still possible to get any kind of return on government bonds?

It’s true that safe-haven government bonds no longer hold the promise of substantial gains in the medium term. But certain paper from the European periphery might be of interest. However, investors need to be careful about their choice of issuers. We currently favour Greek and Spanish government bonds, whereas bonds from Italy are being adversely affected by the country’s stagnating economic growth.

Is there more potential to be found elsewhere in the bond market?

Yes, there is. Bonds from emerging markets and corporate bonds from developed countries are attractive, especially for investors with a long-term investment horizon.

How do you rate equities when it comes to investment potential?

Equities will remain an important investment option in the low interest-rate environment, especially compared with other asset classes. However, the potential for price gains has become limited. Weakening economic growth and higher wages, combined with rising costs as a result of trade barriers, are really hurting companies’ profit margins. Profit rises will therefore be restricted. This means that the valuation of equities becomes a crucial factor. A slightly widening p/e ratio combined with modest profit growth should still generate moderate upward momentum for equities. Picking the right markets and individual stocks is more essential than ever.

Do you favour any other Investments?

Commodities and real estate look attractive. Low interest rates and a late-cycle environment are typically good news for these asset classes.

What do you believe poses the biggest risk for the capital markets?

A few hopes have been dashed in recent months. The global economy failed to generate self-sustaining growth momentum, the trade dispute has not eased and monetary policy conditions are still far from ‘normal’. The positive trend in the market is mainly attributable to the central banks’ decisive action. This has now been priced in by the capital markets. So if the central banks do not proceed as expected or if the trade dispute escalates, the whole situation could backfire.

Do you think this will happen?

No. The inflationary pressure is so low at the moment and the forward guidance from the central banks on this matter is very clear. So if the economy now does not crash, share prices at least should remain supported. In that case, the second half of the trading year could still prove successful, despite the many challenges facing investors.


Unless otherwise noted, all Information and illustrations are as at 1 August 2019