On balance, this year has been very positive for international stock markets with almost all the primary indices showing double-digit gains, of which many exceed 20%. But this result does not take into consideration that the fundamental element which characterized the 2018/19 two-year period is the same; represented by the cooling of the global economic situation accentuated by the Sino-US tariff dispute.
So, the 2019 data should be balanced with the negative results of the equity markets in 2018; to find a correct correspondence between the performance of the real economy and the stock markets. Using this working hypothesis, it is clear that the US S&P 500 index was at the same level in January of last year and in May 2019, thanks to the crash at the end of 2018, recording all the positive annual performance in the second half of this year. The result of the two-year period, an increase of 18%, reflects the fact that the US economy, in the period, recorded an average real GDP growth of over 2.0%; the best among developed countries. Maintaining this evaluation criterion, the fact that in the same two-year period the EuroStoxx 50 index appreciated by 4.8%, is compatible with the substantial stagnation of the Eurozone’s GDP. From a statistical point of view, it may be interesting to note that progress since March 2015 has decreased to a mere 2.3% overall, but also aligned with the disappointing economic situation of the period. The catalyst for the change in the underlying trend of international stock markets is to be found in the umpteenth monetary stimulus intervention, QE4, launched by the primary central banks starting from January with the FED, followed later in the spring by the other issuing institutions, with the important exception of the People’s Bank of China (PBOC).
And it is precisely starting from the Chinese situation that useful indications can be drawn on what could be the stock exchange-currency scenario of 2020, a year which will be characterized politically by the US presidential election in November. Precisely the electoral considerations led to more mild advice from President Trump on the tariff dispute with China, which is moving towards a gradual solution, opening new scenarios on the global economic front and therefore creating new opportunities also in the stock markets. In summary, the disappointing results of this past year achieved by emerging markets, especially in Asia, are due to the constant strength of the dollar in the currency markets and the impossibility for the PBOC to follow the other central banks on the path of monetary stimuli. In fact, the need to counteract the activity of the “shadow banks” that escape supervision, which developed during the monetary easing of 2015/16, but above all the need to control the fall of the yuan in order not to further irritate the US during the tariff crisis, have effectively prevented the Chinese authorities from adequately addressing the slowdown in the domestic economy which is still heavily dependent on exports.
So, the only possible solution for seriously restarting the Chinese economy turns out to be a weakening of the dollar that allows for relaxing support for the yuan, implementing QE4 in harmony with other central banks. In fact, the greenback during 2019 gave clear signs of consolidation on the highs for the period, with the DXY index fluctuating less than 1% over the year. In fact, the elements that supported the dollar in the 2016/18 triennial period, such as a reduction in the Fed’s balance sheet, a moratorium on government bond issuance for budgetary reasons and a decrease in swap loans to emerging countries, are gradually maturing, increasing, in perspective, the availability of dollars internationally, with its consequent probable impediment to further appreciation. To quantify, it is noted that since August the increase of the balance sheet of the FED has reached 34% annualized and that there is room for a further increase of the same by 15% up to a level of 4.5 trillion dollars.
However, we do not assume a marked drop in the greenback but rather its stabilization in a fluctuation band which could be 1.08 / 1.16 against the Euro. Furthermore, we must consider the safe haven component of the dollar, which, with the drastic change of course of central banks and the consequent decreased concern of a world recession, as evidenced by the positive trend of the stock markets, seems to be waning, decreasing surreptitious demand. In practice, the US economy operates as a gigantic alternative hedge fund, financing itself by issuing money that it lends to international investors who buy its government bonds for their high quality, reinvesting their value in high-risk long-term loans, such as those in emerging markets, especially Chinese. However, due to the deterioration of bilateral relations in the two-year period 2018/19, there was an imbalance between the purchase of securities and loans, which resulted in the marked drop in yields on US government bonds and a strong increase in excess liquidity in the domestic financial market, with the consequent paroxysmal increase of stock buybacks by listed companies, which contributed significantly to the stock market increase in 2019. For the new year, the increase in earnings per share for the S&P 500 is estimated to be 6 %, compatible with a further rally of the index towards 3700 points. During the first quarter there could be a moderate correction, induced by the uncertainty created by the impeachment of President Trump, aimed at realizing part of the marked recovery of 2019, given that the modest exposure of investors to the stock market avoided this eventuality at year-end. The prospects for the EuroStoxx 50 are less interesting because the objectively moderate valuations of equities are accompanied by estimates of a continuation of the economic stagnation of the Old Continent until 2021. The Tokyo stock exchange, which performed very well after the summer, still presents compelling valuations that combined with the favorable stock market, is still attractive. The Chinese market remains the true quandary of 2020 in terms of potential, in the sense that it presents very modest valuations but needs a change in monetary policy which is slow to manifest itself. On the other hand, for the other emerging markets and for raw materials, there are currently no particular arguments to garner interest. But the real wild card of the stock market in the new year, is constituted by the essential changes in European fiscal policy, given the clear evidence that monetary policy alone cannot support a credible prospective economic recovery.
In this regard, it may not be accidental that it was decided to nominate Mrs. Lagarde at the head of the ECB, characterized by a strong political acumen, as opposed to a technical Governor in the semblance of Mario Draghi.
Nicola Bravetti Data Source: Bloomberg
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