Last Thursday was an important day for capital markets as the ECB addressed investors’ concerns.
During the meeting, the ECB President Mario Draghi lowered the committee’s forecast for growth in Euroland to 1.4%, 1.7% and 1.8% in 2015, 2016 and 2017 respectively. Its June projections were 1.5%, 1.9% and 2.0% respectively.
Despite the downward revision to growth rates, equity markets rallied on Thursday after the ECB President, Mario Draghi, reassured investors that the committee will increase its quantitative easing program if European growth forecasts continue to deteriorate.
However, markets turned negative on Friday, giving up Thursday’s gains after the US reported that for August the unemployment rate fell to 5.1% and wages rose. This increases the probability of a rate hike on the 17th of September.
It is ironic that positive data resulted in a sell-off in equity markets. Investors are worried that if the Fed had to raise rates, it could cripple economic growth in the US and send the world back into recession.
I think weakness on a day like Friday is a buying opportunity because I don’t think the Fed will be raising rates this September. These are my reasons why:
Data is backward looking
Although data in the US is coming out positive, it is also backward looking. Just like the ECB thinks it is too premature to increase quantitative easing in Europe until it sees a constant trend of negative data, so is it too premature for the US to start raising rates when the rest of the world are lowering growth forecasts.
Emerging markets growth is slowing down
Chinese purchasing managers index (PMI) came in at 47.1 in August, which was a six-and-a-half year low. I do not think the Fed will just look at this own economy without factoring in the ripple effect a significant economy like China could have on global growth. China contributes about 15% of global GDP and close to 50% of global growth.
According to the IMF, in emerging market economies, the continued growth slowdown reflects several factors, including lower commodity prices and tighter external financial conditions, structural bottlenecks, rebalancing in China, and economic distress related to geopolitical factors. A rebound in activity in a number of distressed economies is expected to result in a pickup in growth in 2016.
Downside Risk
According to the IMF, the distribution of risks to global economic activity is still tilted to the downside. Near-term risks include increased financial market volatility and disruptive asset price shifts, while lower potential output growth remains an important medium-term risk in both advanced and emerging market economies. Lower commodity prices also pose risks to the outlook in low-income developing economies after many years of strong growth.
Global growth
According to the IMF global growth is projected at 3.3% in 2015, marginally lower than in 2014, with a gradual pickup in advanced economies and a slowdown in emerging market and developing economies. In 2016, growth is expected to strengthen to 3.8%.
Inflation is still low in the US
US inflation is still way below the current target of 2%. In the second quarter of 2015, the US reported an inflation rate of 0.2% and is expected to increase to 0.4% in the third quarter. I do not see why the Fed should want to create further uncertainty in capital markets when inflation in the US is still very low.
The strength of the Dollar works against economic growth
Year to date, the Dollar strengthened by 8% against the Euro and it strengthened by 14% over a 12 month period. The strength of the Dollar is factoring in an eventual rate hike by the Federal Reserve.
If the Fed had to announce a rate hike in September, it would trigger a continuous increase in the value of the Dollar, leading to downward pressure on economic growth as US exports become more expensive.
Not the wisest of moves when the Fed itself reduced US growth forecasts in its June meeting. Growth forecasts this year ranged between 1.8% and 2.0%, from the 2.3% to 2.7% rise they predicted in March. For 2016, the economy is seen growing by 2.4% to 2.7%, in line with March’s estimate, while 2017 growth is forecast to range between 2.1% and 2.5%. The economy’s long-run growth rate was left at a 2.0% to 2.3% increase.
Elections in the US
The US elections will be held next year. It is not in the interest of either party that the US economy suffers a shock because of a wrong decision taken by the Fed.
Conclusion
Get used to volatility in the equity markets because it is here to stay. Take advantage of days when markets are selling off to add to your conviction names. Do not get intimidated by short term fluctuations and look at the bigger picture.
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.