Equities markets require more certainty on Europe, US, suggests Ashburton’s Tristan Hanson
Tristan Hanson, head of asset allocation at Ashburton, says more certainty about European and US growth prospects is required before equity indices break out of their trading ranges of the past year and a half.
Risk assets have reacted strongly since ECB president Mario Draghi’s comments to do “whatever it takes to save the euro” and July’s better than expected US employment data.
The potentially more aggressive stance indicated by the ECB – primarily buying short-dated sovereign bonds in the secondary market following a request for EFSF/ESM funding – could represent a significant step in European efforts to tackle the sovereign debt crisis. This is because:
- the ECB is the only institution with sufficient firepower to tackle the debt crisis and it had seemed reluctant to step into bond markets again;
- the size of EFSF/ESM funds would be less of a constraint;
- moral hazard risks diminish since countries will be faced with stricter conditionality; and
- the Bundesbank stance looks increasingly isolated within the ECB.
Draghi also indicated further “non-standard” measures could also be taken, which might include further LTROs or looser collateral requirements on ECB borrowing.
There clearly remain risks to a more stable financial environment in Europe. These include the troika review of Greece’s bailout programme and the constitutional ruling in Germany on the ESM bailout mechanism.
Moreover, while Draghi’s guidance has sparked increased optimism there are as yet few details of the new measures, or indeed uncertainty whether Spain or Italy will ask for help, given the additional conditionality that may be applied. And even if tail-risks are reduced, we see little prospect for euro area growth in the coming quarters.
Even so, it is logical that European equities have bounced on the more supportive ECB rhetoric and if the talk is followed by action then further gains would be likely as risk premia contract, in our view.
After a soft patch, recent US economic data has also been encouraging on balance. Weekly jobless claims have started declining once again, lending weight to July’s stronger than expected employment report. There are also clear signs that US housing is turning the corner.
Over the past four quarters, residential construction has added 0.2% to US GDP growth on average.
Manufacturing sector business surveys remain a concern with the ISM below 50, but if labour, credit and housing markets are all improving, it bodes well for ongoing US growth. However, the question of how the looming US fiscal cliff is tackled poses a significant risk to growth prospects. This will be a key risk to watch as the US election campaign heats up.
Valuations are generally supportive of equities relative to fixed income assets, but until these various hurdles (along with those relating to Chinese growth) are overcome, it may be a little while before equity indices decisively break out of their wide trading ranges of the past 18 months.