On Thursday, the ECB readied its latest weapons in the battle to reignite the flame of inflation and reinvigorate growth in the eurozone: a cut in interest rates, TLTRO III, a mechanism for offsetting negative rates against liquidity to appease the banking sector and the revival of the asset purchase programme (€20 billion per year indefinitely). The intended effect, if we may call it that, (a reduction in long-term rates and fall in European bank rates) was to last just a few hours before the markets took on board the relatively negligible impact these measures would have on the economy. It will take more than that to kick-start growth. This will be the job of the national fiscal policy of every state in the eurozone.
Investment in sovereign bonds with long maturities is proving to be a dead end, as it is no longer based on logic. The value of a financial asset depends on its forecast yield (or, in the case of a company, its operational cash-flow). When yields are negative, the investor’s only hope is that someone is going to accept an even worse yield and buy back the asset he holds at a higher price. The central bankers have given it their last shot and, in fact, the unstinting support of the economy is not their sole raison d’être. They also have to protect the monetary systems against distortions in volatility and guard against the development of valuation bubbles. Long-term bonds, property and a certain proportion of listings on the equity market are in a bubble, whilst valuations in other sectors (European banks, etc.), are in crisis or recession. It certainly takes courage to be the only one who is right (and this stance should not be confused with obstinacy or rebellion). It’s much more comfortable to be wrong along with everyone else, where you blend in with the crowd (especially if you were right alongside them before). But you must not listen to the siren songs of those who claim that valuation no longer means a thing and that high-quality assets are capable of paying out more and more, without ever reaching a ceiling. Even though that road is a long one, it ends in a dead end.
And Brexit is another dead end, one which has lasted three years and which is in the process of descending into cacophony. No-one, and certainly not the British public, understands anything about it any longer. The crisis of uncertainty brought about by this simplistic, boolean referendum has now been exacerbated by political leaders who are more concerned about saying the right thing and fooling around in front of the cameras than they are about the real future of their people. While the ulterior motive of some British politicians was to weaken and break up Europe, the United Kingdom may, in fact, have created the conditions for its own disunity, with the Northern and Southern Irish so divided on the issue of their border and the Scottish so pro-Europe. After “Lucky Dave” (David Cameron), “Teresa maybe, maybe not” (Teresa May), it could, perhaps, be the turn of the colourful Alexander Boris de Pfeffel Johnson (the full name of Boris Johnson, also nicknamed “Bojo”) to be dealt the last blow by a Brexit that is still very fuzzy at the edges.
It is time to get back to the simple and sound, and astonishingly, these can now be found in the eurozone equity markets, particularly as the temporary lull in the negotiations between China and the US could prompt the return of an appetite for risk.
Igor de Maack, Fund manager and spokesperson at DNCA. This article was finalised in September 13th, 2019.