Cesar Perez
We believe that volatility in global markets is here to stay, while decent corporate earnings on the back of positive economic growth in developed markets will be the key investment theme for the next year.
Unlike this year, we believe the probability of the central scenario is lower and tail risk probability will be higher – both for positive and negative scenarios.
In Europe, fast credit growth is a potential positive tail event. An increased risk of political disruption is a potential negative tail event, especially with several elections due next year in the eurozone area, including the Spanish general election.
In 2014, the European Central Bank (ECB) finally started asset purchases, tailored to the European fundamentals. The ECB needs to act differently to the Federal Reserve or the Bank of Japan: the transmission of the credit impulse is different in Europe and de-leveraging is not yet completed.
So far, the ECB has bought covered bonds and asset-backed securities (ABS); banks’ balance sheets will benefit in the long run and incentivise the better functioning of European debt markets. The ECB has also ensured banks have the right capital in place (after the stress tests), the right supervision (their own) and the right liquidity (through targeted long term refinancing operations).
Factors such as improving consumer confidence, declining bond yields, currency depreciation, less fiscal drag and the drop in energy prices are working in favour of corporate profitability and GDP growth for next year.
We believe these factors should support a recovery of domestic consumption in Europe. While economic fundamentals feed through to earnings, investors need to see the ECB acting as a safety net against deflation and show its commitment through quantitative easing.
Low inflation has taken hold in most countries in the euro area, core and periphery alike. There are several assets the ECB could additionally buy. The universe of corporate bonds is ripe for picking with approximately €500 billion (Dh 2,238.3bn) available (non-financial bonds rated BB and above).
However, sovereign bonds remain the quantitative easing (QE) instrument of choice for central banks.
In this month’s press conference, the ECB chief, Mario Draghi, mentioned that buying sovereign bonds is a matter of when, not if. The ECB council does not need unanimity for the decision and the asset class is perfectly within the ECB’s buying mandate. Therefore, we believe that we might see QE from the ECB as soon as end of next month.
We believe 2015 will be the ECB’s graduation year. In addition to deflation concerns, the ECB will be challenged by political uncertainties which might drag down countries with a slow moving reforms agenda. Investors will want to be certain of ECB’s commitment to QE before paying a premium for European assets.
Cesar Perez is the chief investment Strategist Emea at JP Morgan Private Bank
Follow The National's Business section on Twitter