Geopolitical tensions are on the rise in many parts of the world. Conflicts are being fought around Ukraine, in the Gaza Strip and in Iraq, and casualties are high. Argentina and the Banco Espirito Santo in Portugal present additional problems.
Encouraging macroeconomic and corporate news did not carry sufficient weight on the financial markets to balance this out
Ben Steinebach Head of Investment Strategy
The encouraging macroeconomic and corporate news did not carry sufficient weight on the financial markets to balance this out. The highest casualty rates are in the Middle East (in the clashes between Israel and Hamas and between the Iraqi army and ISIS). The impact on the financial markets is minor so far, an important factor being that oil prices remain unaffected. That may change shortly, however. Last Thursday President Obama announced that the United States is prepared to take military action in Iraq against ISIS to relieve trapped civilians.
With the threat of an Argentinean national bankruptcy diminished for the present and Banco Espirito Santo appearing to have been rescued following a EUR 4.9 billion capital injection, the focus has turned chiefly to the West’s sanctions on Russia and to the latter’s countermeasures. An additional factor is the threat of a direct Russian attack on eastern Ukraine. As a result, the pattern in recent weeks has been one of classic risk aversion, with stock prices dropping worldwide and bond prices rising in the traditional safe harbours (Europe’s core countries and the United States). The yield on German 10-year government bonds (bunds) fell to 1.03%, an historic low. Conversely, disappointing economic data in Italy and the geopolitical tensions mentioned earlier caused interest rates to rise on the periphery of Europe. Encouraging macroeconomic data from the United States in particular, but also from China for example, and the overall favourable reports of corporate results were not enough to uplift the mood on the financial markets.
Tension caused by sanctions outweighs positive economic news
Although the overall mood on the stock markets last week was discouraging, most of the corporate data published exceeded expectations. With the exception of Germany’s industrial sector the macroeconomic news was also generally positive. First the macroeconomic reports: in the United States the number of weekly unemployment benefits applications dropped to below 300,000 by the end of July, less even than the number from before the financial crisis. Confidence among business owners continues to improve, and a survey among senior loan officers reveals that borrowers are encountering few difficulties.
The situation is in fact showing signs of improvement in Europe, as evidenced by the latest data from the European Central Bank (ECB). This suggests that the credit channels are gradually clearing and the ECB’s policy is therefore apparently having the desired effect. Last Thursday the ECB in fact left the existing very low rates unchanged and kept open the possibility of an Asset-Backed Securities purchase programme. However, President Draghi did express concerns about the escalation of sanctions between the West and Russia and their effect on the European economy, which remains fragile. Encouraging foreign trade data also emerged out of China, indicating a further recovery of global trade.
Last week’s corporate news was on the whole positive. The earnings trend among European companies was even more encouraging than during the first quarter: ING, for example, whose banking business in particular showed strong results. We expect a dividend of EUR 0.52 per share, representing an excellent yield of 5.5%. Switzerland’s Nestlé and Germany’s Allianz also reported solid earnings, as did DSM, particularly bearing in mind the difficulties that the strong euro is causing for that company. The recent fall of the euro will therefore certainly benefit DSM. Despite these favourable developments the rising geopolitical tensions forced the international stock markets down by 1-2% last week. On Thursday the AEX, which had fallen below 400 points once more last week, closed at 394.20 points – 1.1% lower – and on Friday fell even further to below 390 points.
Government bonds still increasingly expensive
The greater risk aversion has forced capital market interest rates as low as they have ever been. The returns on high yield debt rose, conversely, causing the gap with government bonds to widen. Returns on government bonds, which had climbed only last week, fell in Europe’s core countries and the United States. The most important cause was the rising geopolitical tension. However, the decline of Germany’s industry (in terms of both production and order volumes) was concerning and was a contributing factor in causing the 10-year interest rate to drop to 1.03%, the lowest level since the German reunification.
In the United States the yield on 10-year treasuries fell to 2.35%, against 2.51% at the end of last week. The higher interest on the high-yield market stems from a relatively rapid outflow of capital from the market as growth data in the United States exceeds expectations (and demand for capital from companies rises), concerns about Banco Espirito Santo and Argentina and, again, geopolitical tension. As a result the returns on US high yields climbed an impressive 74 basis points, with the increase in Europe lagging at 27 basis points. Considering the encouraging economic outlook, and the resulting decreased risk of bankruptcies and increased merger & acquisition activity (which does not weaken the financial fundamentals), high yields remain attractive at present levels. However, we will closely monitor any signs of disruptive developments on this market.
Corporate earnings reports dwindling
The dominant theme next week will undoubtedly be the geopolitical tensions and in particular the positions adopted by the West and Russia. The busiest period of corporate earnings reports has passed, particularly from the United States, though some interesting macro data are still forthcoming. Besides US corporations Cisco and Walmart, some smaller Dutch companies will be presenting their Q2 earnings: Fugro, Aalberts, Corbion (formerly CSM) and Boskalis. Of the bigger Dutch companies, we look forward to the announcement of Aegon’s earnings on Thursday.
In macroeconomic news quite a few countries will be publishing their inflation data: expect the consumer price data for Italy, France and the European Union as a whole, and producer price figures from the United States. On top of this, in the United States new data will be released about consumer confidence in August (by the University of Michigan) and retail sales in July. Lastly, the Zentrum für Europäischer Wirtschaftsforschung (ZEW) is set to publish its index showing investors’ views on the German and European economies.