European outlook stabilising – investment flows to equities continue
Stocks continued to climb in April following a strong first quarter. European equities were doing particularly well, supported by a good earnings season and lower political risk. The first round of the French presidential election was uneventful and credit risk premiums shrank clearly throughout the asset classes. Companies are currently reporting their Q1 earnings. Earnings have proven to be a positive surprise in the US, Europe and the Nordic countries alike. In Europe, the equity markets have risen clearly and, thanks to the strengthening of the euro, the European equity markets have finally yielded better than the US main markets as of the beginning of the year. Investments continue to flow towards equities and fundamentals in Europe also favor the positive approach on the markets. We are maintaining our neutral recommendation for the equity markets. We will also maintain European companies in moderate overweight and our moderate underweight recommendation for US equities. Similarly, the share of fixed income investments will remain at neutral weight.
- Fixed income: We will maintain fixed income at neutral weight.
- Equities: We will maintain equities at neutral weight.
- Alternative investments: We will maintain alternative investments at moderate overweight.
Interest rates continue to fluctuate in Europe driven by the political risk premium and, on the other hand, strengthened economic development and thus higher inflation expectations. The interest rate on Germany’s 10-year government bond has fluctuated between 0.17% and 0.45%. According to our insight, interest rates have passed rock-bottom in the euro zone. The ECB has not yet been willing to give the markets leave to factor interest rate hikes into forecasts and has communicated very little on the timing of the winding down of the QE programme. We predict, however, that with positive economic development and rising inflation, the ECB will announce late in the year the schedule according to which it will begin to reduce its purchases of second-ary market bonds.
Currently, there is strong demand for corporate bonds and credit risk premiums have tightened to this cycle’s lowest figures. Companies are refinancing their bank loans at a tightening pace and there is reason to be careful also on the corporate bond markets. Even the European derivative instru-ment (iTraxx X-over) that invests in the riskier high yield credit risk market only yields 2.4%. This is not much but with the interest rate floors in negative territory, money is flowing at an increasing rate into corporate bonds.
The early-year rise in the equity markets continued in April. The earnings season has been strong in the US where Q1 earnings were, on average, up to 15% above last year’s corresponding period. Also in Europe, the earnings of companies on the broad Stoxx 600 index were as much as +23% above last year’s Q1, which means that earnings momentum has turned strongly on the old continent. The growth in net sales has also been good but guidance for the future will continue to be cautious across the board.
Macro figures have strengthened but market expectations in the US in particular are at such high levels that real economy figures have not quite managed to reach forecasted levels during the past month. The continuation of the positive element of sur-prise offered up by economic figures would require decidedly more moderate expectations over upcoming weeks. The advancing of the tax reform in Congress is the next significant milestone in terms of the big pic-ture for US companies. To date, Trump’s administration has already backtracked on its tax reform plans during the election. How much faith could be placed in future GDP development and future tax income in terms of US debt sustainability if taxes were to be reduced in virtually all income categories? The markets have not forgotten the debt-ceiling crisis of 2011 when Congress was unable to agree on the raising of the maxi-mum debt amount laid down by law.
Juhani Lehtonen, Head of Fixed Income & Market Strategy Investment Solutions