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Equity markets are caught in a classic ‘hope versus fear’ cycle as investors face a number of major events, says Robeco’s Lukas Daalder.
Stocks went sideways in May, moving within a 1% trading range, apparently unable to decide whether the future will be positive or negative, he says. Fear abounds over the upcoming Brexit vote along with other market-moving events, including central bank meetings in the Eurozone, US and Japan, a Spanish general election, a landmark German ruling on ECB refinancing; and the US Presidential election in November.
However, all these events are expected to pass without any major wobbles for investors, and more structural longer-term factors such as the oil price and US economic strength offer hope instead, says Daalder, Chief Investment Officer of Robeco Investment Solutions.
“It’s hard to escape the conclusion that financial markets seem to have entered a wait-and-see mode,” he says. “Looking at May, for example, stocks finished the month slightly higher, with intra-month moves that were neither extreme nor very directional: one day up, the next day down.”
“This raises the question of what it is that the markets are actually waiting for. Some suggest that it’s the outcome of a number of high-profile events, like the Brexit vote, central bank meetings or the Spanish elections. Unexpected results for any of these could certainly give new direction to the financial markets, but in our experience the market seldom sticks to a calendar when deciding what its next move will be.”
“Mind you, we are pretty sure that an adverse result for the Brexit vote would be a major market-moving event, at least for European and UK stocks, just as a positive outcome could offer a bit of relief. It is important, that’s for sure, but this doesn’t mean that stocks are going to remain motionless, waiting for something to happen.”
Britons are widely expected to vote to remain in the EU when they go to the polls on 23 June, though bookmakers place higher odds on this occurring than do the opinion polls, which predict a closer winning margin. Other upcoming events may similarly turn out to be, well, uneventful, says Daalder.
“Looking specifically at the items on the calendar, we don’t actually expect too many fireworks,” he says. “The Spanish election looks set to become a rerun of last time, and the Fed will probably postpone a rate hike for another month, while it is hard to see how the German Federal Court ruling on whether the ECB’s Targeted Long-Term Refinancing Operations (TLTROs) is constitutional is going to be a real make-or-break issue.”
“The most important item on the list is the Brexit vote, but even here we find it hard to believe that when push comes to shove, the majority of the UK electorate will opt to ‘leave’. Within the EU, the UK currently has the best of both worlds: it is a very competitive economy in the largest internal market in the world, while at the same time it enjoys its own currency and independent monetary policy. A ‘leave’ vote would mean chaos and would badly affect markets.”
So, what then are markets actually waiting for? It’s the usual battle between hope and fear, with a few of the ‘usual suspects’ of Chinese growth and US debt thrown in for good measure, says Daalder.
“Looking at stocks, we would say that they’re currently caught between fear and hope, with neither managing to gain the upper hand,” he says. “In the case of fear, there are plenty of issues that could potentially drag stock markets lower. As we saw during the first six weeks of the year, central banks losing their credibility, uncertainty regarding the medium-term outlook for the Chinese economy, and the significant increase in US corporate debt, with defaults on the rise, could drag markets down aggressively if they all surface at the same time.”
‘Investing in stocks can be a pretty volatile affair’
“These concerns may have now faded into the background, but are certainly not resolved and could therefore flare up again. Also, the market moves at the start of the year have acted as a wake-up call, demonstrating that investing in stocks can be a pretty volatile affair – another factor that will have reduced the allure of the asset class. Added to this is the ongoing deterioration of corporate profitability. This is evident in the earnings-per-share drawdown for the various regions in the MSCI Indices, compared to the highs reached up to this point.”
“On the basis of this, one might be wondering why stocks even recovered to begin with. Enter hope. Stock markets are known for their forward-looking character, as well as for their ability to ‘climb the wall of worry’ – to rise despite everything. Part of this ‘hope’ is due to the easing of some concerns that have been weighing on the market.”
‘This was what you could call the traditional weak first quarter’
“The second source of relief is related to the fact that the US economy did not slip into a recession, as some had feared. First-quarter GDP growth was weak (+0.8% p.a.), but by the looks of the most recent Atlanta Fed estimate for the second quarter (+2.5% p.a.), it looks as if this was what you could call the traditional weak first quarter.”
“So for now it’s hope versus fear. We are not convinced which one of the two will prevail in the end, which is why we stick to our neutral position in equities. On balance we still have a risk-on portfolio position, but this is implemented through an overweight in high yield rather than in equities.”