The German economy’s euphoria seems to have subsided for the time being, but the mood among executives remains good overall, according to the Centre for European Economic Research’s (ZEW) and the Munich-based ifo Institute’s sentiment indicators that were published this week. The survey-based indices that are highly regarded in the financial markets experienced a slight drop from their high levels in February.
At the ZEW, the barometer for economic outlook fell by 2.6 points compared with the previous month and now stands at 17.8 units, with January still marking its highest level since May 2017. The ifo Institute’s Business Climate Index also fell a little to 115.4 units in February after a record high of 117.6 units at the turn of the year.
While the ZEW asks several hundred financial experts for an assessment of the German economy on a monthly basis, the ifo Institute surveys 7,000 managers from German companies. In addition, the ZEW barometer, published two days before the ifo survey, is an important indicator for the latter’s results.
German economy curbs its enthusiasm
Although economists had expected the ifo index to decline less sharply, market reactions were fairly calm: in view of the German economy’s recent strong momentum, market observers saw little room for increases, and so the economic barometer’s slight drop came as no surprise. “The German economy is curbing its enthusiasm,” ifo President Clemens Fuest commented on the figures. However, the ifo experts do not see a reversal of the positive trend.
There are several reasons for the subdued mood. Firstly, a strong euro put a damper on Germany’s export prospects – in recent years, high exports have contributed significantly to the country's economic growth. Add to this the turbulent stock markets in recent weeks, rising key interest rates in the US and US President Donald Trump’s controversial trade policy.
SPD members vote on coalition pact by 2 March
German politics is another uncertainty factor, as the coalition pact barely deals with topics relevant to companies, such as a tax reform, the ifo experts said. Moreover, it is still unclear whether a grand coalition between the CDU/CSU and the SPD will even come about. This depends on the 463,723 party members of the Social Democrats voting on the agreed coalition pact, whose decision will determine by 2 March whether the SPD should participate in the German government again or not. If at least 20 per cent of the members vote, the result for the acceptance or rejection of the coalition is binding for the party's executive committee.
On 1 February, the USA released significantly positive job market data. At an already very low unemployment rate of 4.1%, a further 200,000 jobs had been created. Hourly wages were up by 2.9% year-on-year. All of this seemed like good news. However, the equity markets interpreted the news negatively, and a few days of in some cases heavy corrections ensued around the globe (so-called flash crashes).
Higher interest rates are eating into company earnings
How so? As a result of this actually positive development, investors assume that inflation could overshoot its target. In the event of strongly rising prices (triggered by higher wages), more significant interest rate hikes by the US central bank could be the consequence. Other asset classes such as bonds would gain in attractiveness (at the expense of equities). The yield level of 10Y Treasury bonds has already hit 2.8% (as of 6 February 2018; source: Bloomberg), which has increased said attractiveness vis-à-vis equities slightly. The higher interest rates could turn into a negative factor for the economy and thus for company earnings.
Equity portion in YOU INVEST portfolios reduced
On the one hand there are worries about interest rates rising above expectations, but on the other hand the economic fundamentals are still good, and company results are very satisfactory. In this challenging environment, we as managers of the YOU INVEST funds decided to cut the equity portion to 50% of the maximum quota. This means an equity ratio of 5% for YOU INVEST solid, 15% for YOU INVEST balanced, 25% for YOU INVEST active, and 35% for the portfolio of YOU INVEST progressive.
Corporate bonds almost untouchable
We had used only 70% of the full bandwidth of equities even before the recent turbulences on the stock exchanges. The bond ratios have remained unchanged. We will be parking the proceeds from the sale of the shares on the money market for the time being. Remarkably, corporate bonds have hardly shown any trace of weakness, which is a positive sign in the event of falling share prices and rising volatility (i.e. price fluctuations). We continue to hedge the currency risks.
From January 23 to 26, key economic and political leaders met once again at the World Economic Forum in the Swiss mountain village Davos to discuss global challenges for trade, politics, and climate. The forum, attended by 70 heads of state and government and around 1,900 corporate leaders, focused on “Creating a Shared Future in a Fractured World”.
Among the numerous topics discussed were the risks and opportunities of the cryptocurrency boom, the Brexit’s consequences for London as a business and financial center, and the dangers of right-wing populism for society. In keeping with this year’s theme, heads of state from all over the world, such as German Chancellor Angela Merkel and French Prime Minister Emmanuel Macron, stressed the importance of free trade and closer international cooperation. The Chinese government has also shown its commitment to open markets and globalization.
US Treasury Secretary Mnuchin sends the dollar plunging
In stark contrast to this, US President Trump attended the forum with six of his ministers to deliver his “America First” speech. After having already announced that he would “tell the world how great America is”, Trump’s presence in Davos caused the expected stir. In addition, the President imposed high import duties on solar panels and washing machines from China just before his arrival in Davos, further fueling the trade dispute between the two countries.
A stir also followed US Treasury Secretary Steven Mnuchin’s speech, particularly his comments on the US dollar, which sent the currency plunging. Mnuchin said that a weaker US dollar benefits the US, “as it relates to trade and opportunities”. In response to this, the European Central Bank (ECB) promptly issued warnings of a currency war.
The tension before Trump's speech at the close of the forum was correspondingly palpable. However, fears that Trump would further increase tensions between the US and China and emphasize his protectionist views were ultimately unfounded.
On the contrary, Trump stressed that “America First” does not mean “America Alone” and even kept a foot in the door for a return to the Trans-Pacific Free Trade Agreement (TPP). He also spoke out in favor of a strong dollar, mitigating the US currency’s downward trend triggered by Mnuchin. The press was cautiously optimistic after Trump’s speech: the Neue Zürcher Zeitung saw a possible “hint of a learning process” and the British Times spotted a “significant shift away from ideology and towards realism” in some of Trump's statements.
The Bank of Japan (BoJ) is maintaining its ultra-easy monetary policy for the foreseeable future. At its most recent meeting on 23 January, Japan’s central bank left its deposit interest rate for financial institutions at minus 0.1 per cent, so that banks wanting to deposit money with the BoJ still pay a penalty. The negative interest rate has been in effect since February 2016, the goal being to motivate financial institutions to lend their money for investments rather than deposit it with the central bank.
The move also aims to further boost inflation in Japan. The BoJ recently expressed optimism in this regard, expecting inflation to grow moderately while remaining below target. For Japan – whose economy was paralyzed by a deflationary spiral of falling prices, declining wages and a lack of investments for a considerable time – this is a clear improvement. In November, inflation stood at 0.9 per cent year-on-year after 11 months of unbroken increase. However, the central bank is aiming for a significantly higher rate of two per cent, which means that it is unlikely to abandon its ultra-easy monetary policy in the near future.
Japan currently experiencing longest period of growth since the turn of the millennium
In general, the Japanese economy can look upon a positive development, with steady growth for seven quarters. This marks the country’s longest growth phase since the turn of the millennium. Recent figures for the third quarter of 2017 were also better than expected; the GDP grew by 0.6 per cent from July to September compared with the previous quarter. Projected for the year, this amounts to a growth of 2.5 per cent.
Exporters’ contribution to this development is significant, thanks to strong demand from China and the US. In November, exports rose impressively by 16.2 per cent year-on-year, increasing for the twelfth consecutive month. Imports increased even more strongly, rising by 17.2 per cent. However, this can be attributed to the weak yen, which makes oil imports much more expensive.
The upswing is likely to continue this year. The International Monetary Fund (IMF) recently revised its growth forecast for Japan in 2018 upwards to 1.2 per cent – half a percentage point more than in the forecast from October – due to the unexpectedly well-performing economies in Asia and Europe.
The stock market is picking up on the good mood pervading the Japanese economy: The country’s leading index, the Nikkei-225, currently stands at around 24,000 points, the highest level in 26 years.
One year after Donald Trump's inauguration as President of the United States, the only way for the US stock market is up. In 2017, the Dow Jones Industrial Average Index, the world's leading stock market barometer, rose nearly 25 per cent. On Tuesday, 16 January, the Dow topped 26,000 points for the first time in its history, having hit the historic mark of 20,000 just one year earlier.
The S&P-500 index, comprising 500 selected US companies, and the US technology index Nasdaq Composite also boasted strong gains since Trump has taken office. The S&P-500 has increased by around 23 per cent since January 2017, Nasdaq by around 31 per cent.
If the US president is to be believed, the current optimism among investors is due to his very own efforts: “The reason why the stock market is so successful is me,” Trump praised himself. Economic trends were indeed very positive in 2017: job markets are more or less showing full employment. The International Monetary Fund currently estimates 2.2 per cent US economy growth for 2017, with the last quarter’s three per cent being the highest since the beginning of 2015. In addition, the US tax reform, successfully passed just before Christmas, made the markets happy, providing massive tax relief for companies and wealthy Americans.
Experts view Trump’s contribution to US economic upturn as negligible
According to experts, however, Trump's contribution to the economic upswing in the USA is low to nil. Gustav Horn, head of the German Institute for Macroeconomics and Economic Research (IMK), for example, explains that the trend started long before Trump took office. If anything, the president's contribution lies in not hampering the upward trend.
The tax reform also increases the US’s attractiveness as a business location and could contribute to relocating manufacturing to the US in the longer term, but will also increase the deficit, as the state is giving up income. This is not how a sustainable economy works, says Dennis Snower, president of the German Institute for the World Economy. Trump may have provided a stronger superficial and short-term boost for the economy and the stock markets than expected, but “this is not positive”.
“It is much more likely that the next crisis will come sooner due to the political actions of Donald Trump. And we are in a worse position to combat it, because many of the problems we face must be dealt with internationally,” warns Snower, also accusing Trump of fragmenting society. Horn sees Trump’s protectionist trade policy as a threat to world trade, especially if the controversial US president’s approach causes others to jump on the bandwagon.
However, the markets are unlikely to worry about this – at least so far, there is no end to the party mood in sight.
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