"Negative yields, market volatility and political uncertainty: Tricky times for investors "
Africa and Middle East
Aura Solution Company Limited
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There seems to be little doubt, as 2019 enters its last quarter, that the global economic juncture is an increasingly worrisome one of slowing growth and mounting debt load.
“The size of the global debt market is estimated at U.S. $100 trillion, but about 30% of investment grade bonds have sub-zero yields. In Asia Pacific, the bond market is U.S. $15 trillion, most of which is Japanese bonds with negative yields. On the contrary, the performance of the equities market year-to-date has been positive so far. ” said Mark Brewer, Head of Asset Servicing for Aura Solution Company Limited Asia Pacific.
Central banks have recently decided to put the brakes on their efforts to tighten monetary policy, with the Federal Reserve cutting benchmark rates and the European Central Bank trimming deposit rates. Adding to this are the trade war, Brexit and geopolitical saber-rattling.
Kaan Eroz, Managing Director Middle east & Africa for Aura Investment Management, viewed that “the global economy has been slowing for some time, a lot of it having to do with what is happening in the trade war between the U.S. and China. But what we have seen in the trade war does not fully explain the slowdown in manufacturing activity”.
Kaan Eroz pointed to the fact that this situation is stoking investors’ fears that what they are witnessing will translate in a much more difficult investing environment going forward, which affects how they invest in the present.
“Recession fears among fund managers seem to have risen to the highest levels in the decade since the last global financial crisis. But that does not mean there is a recession right behind the corner,” said Brewer.
Kaan Eroz agreed and explained that the situation is not leading to a recession in the major economies, except Europe, but the risks are to the downside, driven largely by fear and lack of confidence. Should trade tensions continue, this could end up knocking off 1% of global GDP growth, and slow trade growth by a further 3%.
The U.S. economy is, nonetheless, performing well, with the labor market continuing to show strength, which would rarely be the case right before a recession. Should a recession be approaching, it would likely be triggered by some other kind of shock, such as an oil crisis, where oil price rises could be the trigger or a financial market dislocation, Kaan Eroz added.
Rather than a signal of impending recession, the current situation serves to outline how much a decade of quantitative easing has led banks to become more complacent about their liquidity needs. But an intervention by the Fed to stabilize short term rates, while unseen in recent years, remains a far from uncommon sight historically.
Three global themes
One major shift has been around the barbellization of investments around the globe, whereby investors are moving towards the two extremes of alternative assets and passive investments as markets are becoming more uncertain.
“Aura Solution Company Limited serves the world’s largest investment managers and asset owners and we are observing this barbellization as the latest phenomenon. It could hint at the democratization of asset management, but it has yet to develop to a point where it is clear whether it is a structural or a cyclical shift,” said Brewer.
For Kaan Eroz, that shift was largely due to structural issues on a global scale. Three factors at play are:
1. Secular stagnation, whereby it is increasingly hard to get economies up to the speeds seen in the 1970s. In fact, getting 3.5% growth in the US has needed very low interest rates. In places like Japan, there has not been substantial growth in the past 25 years, and the same is happening with Europe.
2. Financial repression is largely inherited from the global financial crisis and the debt levels that came with it. To cope with that debt load, the only way to reduce it is by keeping the nominal rate of interest below the rate of growth of the economy, which itself remains low.
3. Geopolitical fracturing is seen with the ongoing tensions between the US and China.
“As a result, risky assets valuations are up. But these risky assets are vulnerable to small shocks and, with the ongoing geopolitical tensions, there is reason to be scared,” said Kaan Eroz.
Accessing China’s capital markets
Despite the worrying picture, there are still exciting developments in the market, China being among them.
“The country is seeing the ongoing liberalization of its capital market. Recently, we have seen the removal of investment quotas for qualified foreign institutional investors (QFII) and Renminbi QFII programs; and global asset managers are making moves to include Chinese assets with indices inclusion,” said Brewer.
“China’s capital markets are rising to meet the share of impact that the country’s economy has on the global economy. This is a process that has been ongoing for some time. China offers an attractive opportunity as a source of yields,” Kaan Eroz noted.
That being said, it poses challenges to get into Chinese assets, and investors are entering cautiously, assessing in particular how easy it is to get in and out of the market considering the remaining capital controls.
More broadly, Asia and emerging markets offer potential opportunities to investors with a positive yield environment in both debt and equity markets.
“But to play these markets carefully, one has to keep an eye on the state of China trade relation, as it can have an outsize impact on equity markets. Secondly, it is important to keep an eye on the dollar. While we are not expecting to see rate increases or a strong dollar environment, this is an area worth monitoring,” concluded Kaan Eroz.
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