Market activity on the wane?

Investment Policy, August 2021

Market activity on the wane?

When financial market participants go off on their holidays and pursue activities other than the observation of financial markets, a decline in trading volumes is often the result. At times like these, even minor news stories can trigger significant market fluctuations. For that reason, greater volatility – in both directions – coupled with declining trading volumes is often a characteristic of the financial markets in the summer weeks. This is true not just of equities, but also other asset classes. As many market players will surely be particularly keen to head off on holiday this year, a pronounced spike in volatility in both directions would come as no surprise.

A number of important factors is influencing the third quarter of this year. First and foremost, the global economy is performing well, with the momentum now clearly shifting more towards Europe following previous strong development in China and the US. This upturn is being supported by the reopening of parts of the European economy, as well as by historically high confidence levels on the part of both companies and consumers. In the United States, attention has now switched to the labour market, which is likely to be a key point of focus in view of a possible scaling-down of bond purchases by the US central bank (Fed). Another significant factor for the development of financial markets and the economy is the question of how long various bottlenecks in the supply of certain goods (e.g. commodities, semiconductors, certain supplier components) will persist. Such scarcity of supply could weigh on the production side of the global economy on the one hand, but it could also have an impact on inflation on the other (which has already risen due to these shortages). From an economic standpoint, therefore, this summer will remain interesting.

Equities
While equity markets are currently being supported by a healthy economy, they also have historically high valuations. That said, the latter feature applies more to the US than it does to Europe. The upward march of inflation has also been more pronounced in the US than in Europe. This can be seen in the higher inflation forecasts on the part of the Fed compared to the European Central Bank (ECB) or Swiss National Bank (SNB), for example. But the communications emanating from Europe’s key central banks are also clearly more indicative of a continuation of expansionary monetary policy. This, together with Europe’s more attractive equity market valuation, could lead to greater capital flows of international – and particularly US institutional – investors into European equities. For this reason, we have been overweight in European equities compared to their US counterparts ever since the start of 2021. Where the emerging markets are concerned, we are currently adopting a neutral positioning. While valuations are not uninteresting, faltering economic momentum in China and a more acute coronavirus situation in the other key emerging market countries in a global comparison must also be taken into account.

European equity markets continue to look more attractively valued than their US counterparts.

Gérard Piasko, Chief Investment Officer

Bonds
The decline in yields at the long end of US yield curves in June was somewhat surprising. It appears that a number of market participants are assuming that the Fed’s slightly less expansionary monetary stance will on its own suffice to reduce the rise in US inflation that we have recently observed. However, given the range of factors that influence inflationary developments (cf. our Market Comment for May, “The inflation debate – an update”), this would appear far from certain. The summer months must be left to run their course before we will know whether the current surge in inflation is a short-lived blip or not. For that reason, fixed-income positions involving very long durations will remain risky. Corporate bonds appeal more than government bonds in this situation, as they are currently benefiting directly from the improvement in corporate earnings. Investment Policy, August 2021 Market activity on the wane?

Currencies
Our view that currency markets are being driven more by two-way volatility than any distinct trends – a view that we have reiterated on a number of occasions this year – continues to apply. Specifically, two contrary forces are influencing the movement of the US dollar against the Swiss franc, and to a significant extent also the euro: On the one hand, strong fiscal stimulus stateside has given the greenback a certain interest rate advantage that has actually strengthened further compared to 2020. On the other, it is precisely this stimulus that is leading to an increase in the US budget deficit compared to budget deficits in Europe – essentially an unhelpful development for the US dollar. It would therefore not surprise us if, for example, EUR/USD were to remain in a bandwidth of just a few percentage points around the 1.19 mark for quite some time, with the corresponding two-way fluctuations of a few percentage points in both USD/CHF and EUR/CHF.

Commodities
The two-way volatility evident in the currency markets has also been apparent in the price of gold over the last few months. While gold benefited from the decline in the US dollar back in the early spring, reverses amounting to several percentage points were then apparent in June. These were triggered by changes in the level of inflation-adjusted US bond yields. These so-called “real” interest rates rose when the Fed indicated at its June meeting that it was now anticipating two interest rate rises of 25 basis points each in 2023, having previously not envisaged any rate increases at all in that year. Real interest rates are important to the price of gold, as they factor in not only the opportunity costs of investments that do not generate any return in the form of interest or dividends (such as gold) but also the relative attractiveness of gold as a repository of value, depending on the development of inflation. Like with other commodities, therefore, gold looks set to exhibit greater volatility in the coming summer weeks, as every word uttered by a US central bank in respect of monetary policy is bound to be carefully weighed on the “gold scales”.

Gérard Piasko

Gérard Piasko

Gérard Piasko is Chief Investment Officer and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years Chief Investment Officer of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Editorial deadline: 14 July 2021

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Redaktionsschluss: 14. Juli 2021

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