In this month's edition:
Is Italy's budget a concern for bond investors?
Mounting concerns about the Italian government's expansionary budget plans have driven the yield on two-year Italian bonds sharply higher. While Italy's credit rating is likely to be downgraded by one notch, the country is likely to retain an investment grade rating for at least the next 12 months. We see risk in long-dated Italian bonds, we believe the recent sell-off in short-dated bonds is overdone.
Did you know?
In early May, Italian two-year yields were at minus 33bps, even though March's general election had failed to provide an outright victor.
By 29 May, two-year yields surged to 276bps ahead of the eventual formation of a populist coalition between the League and M5S parties on 1 June.
The spread between 10-year Italian and German government bond yields has increased from an April low of 117bps to 285bps. But this remains well below the peak of 527bps reached during the 2011–12 Eurozone debt crisis.
Will a trade war crash markets?
US protectionism has raised concerns that simmering tensions could boil over, resulting in a full-scale global trade war. Most recently, the US implemented tariffs on USD 200bn worth of Chinese imports, with China immediately responding with tariffs on USD 60bn of US imports. The US has also threatened tariffs on a further USD 267bn of Chinese imports. We believe that tensions will likely get worse before they get better, while de-escalation is a high-probability upside risk case that could prompt a relief rally in markets. Meanwhile, we see only a 5% risk of a global trade conflict.
Did you know?
NAFTA is the most important trade issue in terms of its direct impact upon the US economy. US exports to China totaled about USD 32bn in 1Q18—vs. USD 137bn of US exports to Canada and Mexico.
Among Chinese listed stocks, international sales make up a low-teens percentage of total sales, of which the US accounts for 20%. This implies that their direct sales exposure to the US is around 3%.
Is an overheated global property market a risk?
With the current bull market in global stocks now in its tenth year, many investors are focused on whether stock valuations have become too rich. But it is possible that many investors are sitting on a more clearly overvalued asset – their homes. Over the past five years, home prices in the top 20 global cities have risen at more than twice the pace of rents. We believe signs of property market overheating across much of the globe further increase the importance of balance in other parts of investors' portfolios, especially avoiding concentrated risks. Property prices are now either in bubble territory or overvalued in 16 global cities tracked in the UBS Global Real Estate Bubble Index, which compares prices with levels of rent, income, and inflation.
Did you know?
Over the past five years, house prices in major cities have increased by 35% on average. In San Francisco, Munich, and Vancouver price growth was double the average.
An average worker would need to work 22 years to afford a 60m2 flat in Hong Kong. Ten years ago it was just 12 years.
You would need to work just 5.7 years to afford a 60m2 flat in Milan—the most affordable real estate market in Europe.
Can a Brexit deal be reached?
Concern over Brexit is rising, with the UK government at the limits of what it can concede and Prime Minister Theresa May stating that not reaching a deal "wouldn't be the end of the world.” Delays increase the risk of no deal being reached. Our base case remains that an agreement can be reached and that the UK will move on to the transition phase, but this is likely to come later than expected, and the risks of no deal remain very high. Find out more in this month's UBS Investor Forum.
Did you know?
The proportion of UK exports going to the EU has been declining. In 2016, it was about 43%, while 54% of UK imports came from the EU.
Without a trade deal, UK exporters would face GBP 5.2bn in tariffs on goods sold to the single market, while EU exporters would face GBP 12.9bn in tariffs on the reverse trade, according to estimates by Civitas.
In a UBS Industry Leader Network survey, the majority of business leaders felt that the EU-UK economic relationship will remain largely unchanged during the Brexit transition. But some have already noticed changes in business activity, with multinationals restructuring internally and shifting orders back to local markets.
What are the real risks to the bull market?
Global stocks are enjoying their longest bull market in modern history, and the economic expansion's length will enter uncharted territory by the end of 2019. But old age doesn't kill bull markets, and neither do geopolitical crises. Recessions and bear markets are usually accompanied by overextended credit conditions or an overheating economy. Based on our Bull Market Monitor and our Global Risk Radar analysis, faster Fed tightening is the bull market's primary threat, with a low (10–20%) chance of triggering a recession in the next 18 months.
Did you know?
While the Federal no longer refers to its monetary stance as "accommodative," financial conditions remain loose, with easy access to credit for most debtors.
The misery index (the sum of US inflation and unemployment rates) is a key indicator of economic health, with a low reading indicating a supportive mix of growth and inflation. At 6.6%, the current level is among the lowest 20% of readings since 1948.While geopolitical events often leave a lasting mark on society, the "Political flux" simulation shows that markets—and economic cycles—have proven remarkably resilient to such crises.