Muddling through with low interest rates


Central bank action has supported markets this year but we need to see a recovery in corporate earnings.

The world should escape a general recession this winter. The forecast manufacturing downturn has occurred, led by falls in vehicle output. Individual countries have flirted with recession. Italy was in a shallow recession last year, and German output has fallen this year.

Equity markets have performed well so far in 2019, despite the slowdown in activity and the falls in company profitability we have witnessed. This mainly reflects the action taken by central banks in most parts of the world to promote more growth. There have been interest rate cuts from the US, India, Brazil, Australia and other countries. The European Central Bank (ECB), the Federal Reserve, the People’s Bank of China and others have undertaken monetary easing measures. The Bank of Japan has carried on buying bonds and Japanese shares through index funds, and the ECB has re-started its bond buying programme. This has given direct support to financial markets. It means that shares have got progressively more expensive as the markets have risen, owing to a poor earnings performance overall.

There may be a mini deal between the US and China to prevent the trade dispute getting worse. This will probably require bankable promises about Chinese purchases of US farm produce with some language on higher standards of intellectual property protection in China. In return, the US will need to promise no more tariff rises and maybe some rollback in ones already imposed. China is briefing she wants to see a mutual reduction in tariffs as part of a deal. It is unlikely there will be a comprehensive agreement, leaving China and the US locked in competitive disagreement over many things from political issues through to trade matters. The danger is that, at the last minute, President Trump declines any negotiated proposal, disappointing markets again.

There should be a bit more easing action to see the economies through the current rough passage. China in particular will need some more stimulus, but is proceeding cautiously given the current levels of debt and difficulties with some of the banks. The authorities there are wrestling with the need to restrain excess debts in the old economy and sort out bad debts, whilst trying to route loans and capital into new faster growing areas. The new President of the ECB, Christine Lagarde, will need to look at what more can be done to ease the slowdown in the Eurozone.

It looks as if inflation will stay under reasonable control given the willingness of many people to join the labour markets directly in the advanced world through migration or indirectly through exports of goods and services to the richer countries. There remains plenty of surplus capacity of goods and raw materials, limiting the scope for price inflation. The US is the closest to more inflation, thanks to low unemployment and continuing fiscal and monetary stimulus. As a result, it looks as if interest rates will stay low for the time being, removing one of the most serious threats to asset prices. The main currencies look fairly aligned.

We think both bonds and equities look quite expensive after a great year of returns for both so far. In the short term, the recent bond sell-off makes them look a bit more attractive relative to shares, where the US market is hitting new highs again. It needs a boost to company earnings as we enter the next year to make equities better value. US Treasury bonds offer the best yields amongst the major sovereign issuers. Expensive government bond markets remain supported by low rates and in some cases by active central bank buying. Markets are still muddling through.


The above article was previously published by Charles Stanley on 7th November 2019