the scottish enlightenment: the silver bridge between newton … · 2015-01-05 · onthly strategy...

MONTHLY STRATEGY REPORT April 2015

The Scottish Enlightenment: the silver bridge between Newton and Einstein

Alejandro Vidal CrespoService Director, Investment Strategy

Monthly Strategy Report. April 2015

The Scottish Enlightenment: the silver bridge between Newton and Einstein.

“We tell a story about how quality education and investment in hidden talent across all layers of the social strata can generate genuine scientific and technological revolutions, with unimaginable consequences at the time of investment. In modern society, where knowledge is transmitted almost instantaneously, true added value hinges on the promotion of research and technological development, free thought, and think tanks where different scientific disciplines can engage openly to push the boundaries of our understanding.”

Scotland in 1707 was one of the poorest regions in Europe. That year, the Acts of Union were passed, formally uniting the kingdoms of England, Scotland and Wales to form the Kingdom of Great Britain. Although it involved the permanent eradication of state structures, it also ended a conflict that dated back to the expulsion of the Stuart dynasty. Thus, Scotland overcame a period of almost continual confrontation with England, which had appropriated many economic and social resources. England ceased to view Scotland as a rival and began to endorse any measure that would strengthen the Scots, who also had access to free trade with the rest of Britain and its empire.

At its core, the Scottish church was Calvinist, a branch of Catholicism particularly dedicated to education, since it was considered to be the duty of the clergy to bring knowledge and tuition to the masses. The economic boom that resulted from trade and Calvinist thought gave rise to the creation of a public education system for all levels, including basic training at primary schools and intellectual development at universities, primarily those of Glasgow and Edinburgh, which became known as the Athens of the North.

The first major achievements of the Scottish Enlightenment came in the fields of thought and philosophy with two pivotal figures, Francis Hutcheson and, particularly David Hume, who expanded scientific thought by devising his own method, established new correlations between science and religion, and developed the Problem of Induction. As thinkers, they were steadfast empiricists dedicated to scientific experimentation as a way to develop new ideas, shunning preconceived notions. On this foundation of modern scientific thought, in a climate of remarkable liberty in the fields of instruction and experimentation, Scottish universities began to break the mould and make impressive strides in all disciplines.

Take, for example, Adam Smith, author of An Inquiry into the Nature and Causes of the Wealth of Nations, the work that launched liberalism and modern economic theory, in which Smith addresses issues of economic policy, human capital, and the division of labour. Or James Watt, a mechanical engineer and inventor of the steam engine, a radical innovation that facilitated the development of industry and transport, and put Britain at the forefront of global progress.

But perhaps the most decisive breakthrough occurred in the field of physics. To date, the prevailing ideas had been defined by Newton, the 17th century scientific genius. Isaac Newton had made fundamental advances in several fields, including mathematics (with the development of differential calculus and our beloved derivatives and integrals), physics (with his study of optics), and astronomy, with his famous laws of universal gravitation and motion, and particularly the idea that the same laws which govern the movement of bodies in the universe also govern movements on Earth. With these he defined the existence of universal laws that prevail regardless of the time or place in the universe at which a given event occurs.

But these theories would change thanks to the work of a young Scottish mathematician named


James Clark Maxwell. From his position at the University of Edinburgh, Maxwell avidly followed the development of a recent discovery, electricity and magnetism, and specifically the experimental work of London scientist Michael Faraday, who had successfully generated electricity from a magnetic field. However, despite having obtained empirical data about electricity, Faraday was unable to explain his finding mathematically, using laws.

Maxwell reinvented the concept of how forces are transmitted and defined the notion of a force field. He applied Newton’s differential calculus to create a grid that acted like a network, interacting with certain particles by attracting or repelling them according to their nature and position in space and time. This meant that the Newtonian idea that forces were transmitted instantaneously and directly through space had been supplanted: the universe consisted of force fields of different natures.

He was also able to unite heretofore incongruous laws. Using the new law of fields, he combined electricity and magnetism, demonstrating that they were different manifestations of the same force (electromagnetism). This unification enabled the development of electricity as a manageable force, with its subsequent implications for the field of technology. But Maxwell’s contributions didn’t end there. He discovered that electromagnetic fields could move through space together in the form of waves – electromagnetic waves – and that these waves moved at a constant speed (he estimated with near precision the speed of light) and existed in several forms, from very short to very long vibrations, and that visible light (ie: the colours) were only part of a larger spectrum. He had defined the nature of light.

In reality, radio, x-rays, visible light, and heat were electromagnetic waves moving at the same speed with different periods of vibration. This discovery, coupled with that of the specific properties of each type of wave, formed the basis of the technologies that would flourish shortly thereafter, such as the radio, the radar, x-rays, heat transfer, and space exploration, because we can see the universe in many different frequencies.

In 1890, the implications of Maxwell’s finding were still being put into practice by, among others, a German scientist named Max Planck. His task was simple: to quantify the amount of light emitted by a hot metal filament in order to produce the most efficient lightbulb possible. But how does one measure the amount of light? Planck discovered that light energy is transmitted in constant packets, or quanta, which he defined as photons in the case of light, that in turn were produced by electrons bounding in metal atoms as a result of electricity. This concept would give way to the field of quantum physics and ultimately produce the tools necessary for Einstein to develop the basis of both 20th and 21st century physics, since the development of quantum computers will be one of the key features of the technological revolution yet to come.

Are we capable of regenerating forums like the Academy of Athens and the Scottish university?

MONTHLY STRATEGY REPORT April 2015

The ECB and a cyclical upswing boost European markets

Banca March Market Strategy Team:

Miguel Ángel García, Unit Director, Market StrategiesRose Marie Boudeguer, Service Director, Research Services

Pedro Sastre, Service Director, Market StrategiesAlejandro Vidal, Service Director, Market Strategies

Paulo Gonçalves, Specialist Technician, Research Services Miriam Ordinas Sanjuán, Specialist Technican, Market Strategies


The ECB and a cyclical upswing boost European markets

A very positive quarter for European markets…

We close the first quarter of the year with notable behaviour from European stock exchanges, which rose considerably, bolstered by the monetary stimulus measures of the ECB and improved activity data.

…which prevailed with support from ECB measures despite doubts about Greece.

These factors enabled the markets to overcome uncertainties from Greece, where an agreement that would unlock new tranches of financial assistance has yet to be reached. Liquidity tensions increased in the country, and with them, the risk that the Hellenic republic would default on its debt. As a reflection of the situation, the ratings agency Fitch downgraded Greece’s public debt rating to CCC, the level established for substantial default risks.

Geopolitical tensions escalated in the Middle East, with the military intervention of Saudi Arabia in Yemen to curb the offensive of Shiite militias. Though Yemen is not a major oil producer, its geostrategic position could jeopardise oil transport.

Attention remained focused on monetary policy…

The Central Banks continue to play a pivotal role, with the markets eagerly awaiting announcements from the Fed. The US monetary authority has decided to keep interest rates unchanged at 0%-0.25%, but in a new development, the Fed dropped the word “patient” from its statements, opening the door to future rate hikes. Increases will not occur before June however, and are contingent upon the continuation of good economic performance. The Federal Open Market Committee (FOMC) members themselves cut their outlook for official rates: the new median for the close of 2015 shows rates at 0.625%, down from 1.125% in the December statement, which suggests that future increases will be very gradual.

…the Fed is in no hurry to raise interest rates…

Regarding expectations about the economy, the Fed lowered its GDP growth forecast to a range between 2.3%-2.7% (vs. previous estimates of 2.6%-3%), and also expects lower inflation. Employment prospects are more positive, considering the unemployment rate will hover between 5%-5.2% by the end of the year.

…and the ECB began its public sector purchase programme.

For its part, the ECB began its public sector purchase programme, acquiring over EUR 40 billion in sovereign bonds since 9 March. In addition, it launched the third tranche of long-term loans (TLTRO), allocating EUR 97.8 billion and raising the total amount of liquidity injected through these operations to EUR 310.288 billion since September.

After a considerable upward revision, new growth forecasts were announced. According to the ECB, the positive effects of falling oil prices, the monetary stimulus, and the depreciation of the euro will boost activity. Specifically, it estimates a rise in GDP of 1.5% in 2015 (vs. 1% previously) and 1.9% in 2016. Regarding inflation, the ECB cut its earlier forecast to 0% year-on-year in 2015 (vs. +0.7% previously), but raised the estimate for 2016 to 1.6% (vs. 1.3% previously).


Eurozone activity improved.

The eurozone’s macroeconomic data surpassed expectations. Confidence indicators continue to improve, with the composite PMI climbing to 54.1 and consumer confidence at its highest level since 2007. In terms of activity, industrial production accelerated in January to +1.2% year-on-year. The unemployment rate, though still high, dropped one tenth in February to 11.3%. Regarding prices, the preliminary CPI moderated its decline in March by two tenths to -0.1% year-on-year.

The upward revision of growth prospects continues in Spain.

In Spain, forecasts continue to be revised upward, with the Bank of Spain raising its growth forecast for the year to 2.8% on higher domestic demand contributions. The tourism industry also released positive data, with the arrival of international visitors up 4.5% year-on-year. It’s worth noting that this economic upturn cuts the government deficit, the accumulation of which fell 8.8% year-on-year to 1.09% of GDP as of February (vs. 1.22% the previous year). Negative inflation persists, with the CPI in March at -0.7% year-on-year (vs. -1.1% previously).

The beginning of the year was less dynamic for the US economy.

Activity data in the United States were mixed, affected in part by snowstorms. In the construction sector, housing projects initiated in February fell 17% monthly and construction spending declined for the second month in a row. The pace of job growth slowed with 126,000 jobs created in March, fewer than the previous 264,000. On a positive note, consumer confidence recovered, surging to 101.3 according to the Conference Board index. Lastly, inflation saw zero growth in February, while core inflation rates rebounded one tenth to +1.7% year-on-year.

Activity data in Japan were negative.

The Japanese economy remains weak, with February declines in both industrial production (-2.6% year-on-year) and retail sales (-1.8%). Inflation eased once again with core CPI levels at +2% year-on-year (vs. +2.1% previously). In this climate, the Bank of Japan continued its aggressive monetary stimulus policy, awaiting signs of recovery.

High growth rates continue to moderate in China.

Also in Asia, the Chinese government lowered its target GDP growth rate for the year by five tenths to 7%, and announced that it would increase fiscal stimulus measures this year – in which the public deficit is expected to reach 2.3% of GDP – as a way to promote growth. This decelerating trend is confirmed by the data published: retail sales in the first two months of the year rose 10.7% year-on-year (vs. 11.6% previously) and industrial production was up 6.8% year-on-year (vs. 7.7% previously). The CPI rebounded in February to +1.4% year-on-year from +0.8% previously.

In Brazil, sluggish growth joined political uncertainty.

In Latin America, protests against the administration of Dilma Rousseff in Brazil and the sharp decline in her popularity have triggered concerns about the stability of the office at a time of sluggish economic growth. However, on a positive note, the ratings agency S&P maintained Brazil’s credit rating at BBB- (investment grade) with a stable outlook.

The expansionary monetary policy continues to push bonds.

In Europe, the launch of the ECB’s bond-buying programme, and in the United States, the Fed’s declaration that it will move away from aggressive rate hikes, boosted public debt prices. US 10-year bond yields fell 7 b.p. closing the month at 1.9%, while German bond rates for the same


maturity plummeted 15 b.p. to 0.18%, a new low. Earnings on peripheral bonds remained stable, with the exception of Greece because of uncertainties about the unlocking of aid. Interest rates on Spanish 10-year bonds declined to 1.2% and the public debt ratio performed at 1% in the month, to close the quarter up 4%. In credit markets, high-yield bonds performed worse on rebounding spreads demanded from companies. Globally, the debt index of lower-rated credit dropped 0.3%.

Uneven stock market trends, with positive gains in Europe throughout the quarter.

In March, global equities fell 1.8% on the poor performance of US stock markets which, in the case of the S&P 500, contracted 1.7% in the month. Emerging markets also closed the month in the red with the MSCI Emerging Market Index declining 1.6%. In contrast, European stock markets continued to advance, with the EuroStoxx50 gaining 2.7% in March, bringing quarterly earnings to +17.5%. By country, the German stock market has performed admirably, up more than 22% in the year. Though trailing, the Ibex35 also fared well, climbing 3% in March and 12% in the quarter, its best performance in 17 years.

The euro accelerated its decline.

In currency markets, the euro accelerated its depreciation due to the ECB’s expansionary measures. In the crossover with the dollar, it lost 4.2% over the course of the month, and 11% in the quarter to close at 1.07 EUR/USD. The yen also gained ground against the euro (+4% to 129 EUR/YEN). The pound sterling was the exception, remaining stable against the euro in March, with a crossover of 0.72 EUR/GBP.

Oil and gold prices continue to sink.

Oil prices corrected from hikes in the previous month and the price of a barrel of Brent fell to $55, for a 12% decline in March. Current inventory levels remain high, slowing any potential price increases. Gold accelerated its decline, maintaining a negative correlation with the rise of the dollar: the price per ounce fell 2.5% to $1,184.


Strategy for April 2015

ASSET ALLOCATION

Positive Neutral Negative

Shares Bonds

Cash

ASSET ALLOCATION

Positive Neutral Negative

Equities

Europe Japan

USA

Emerging countries

Bonds

Peripheral Bonds Government Bonds(AAA, AA+)

Corporate Debt“High Yield”

Corporate Debt“Inv. Grade”

Convertible Bonds

Emerging debt

The economic data confirm the recovery of the eurozone.

The macroeconomic data released in March continued to confirm the eurozone’s recovery in terms of activity, employment, and inflation. Indicators of economic confidence, consumer confidence, and business confidence were also very positive – all signs that the rebound will continue in the coming months.

In the US, a weak start to the year appears to be temporary.

The news from the United States indicates that the weak economy in the first three months of the year is temporary, due to inclement weather on the east coast. While investment and consumption data were mediocre and the latest employment figures were dismal, business- and consumer- confidence levels point to more dynamism in the coming quarters.

In China, the central bank may implement new stimulus measures.

In China, business confidence remains at levels that indicate growth rates lower than the targets stipulated by the authorities. However, the Central Bank of the Republic of China may institute new monetary stimulus measures, either in the form of decreased reserve ratios, lower interest rates, or both.

Large disparities in the emerging world, though the weakest countries saw slight improvements.

The situation varies in the remaining emerging markets. India and other Asian nations have benefitted from lower energy prices and the appreciation of the dollar, while commodity-producing countries are suffering from deteriorating terms of trade, despite having managed to reduce official rates and boost domestic demand. Brazil and Russia, with very low activity and confidence levels, may be showing signs of bottoming out economically and politically. Eastern European countries appear to have improved in tandem with the recovery of the eurozone, low oil prices, and a more expansionary monetary policy.

Geopolitical tensions fail to eclipse the economy.

Financial markets have also been attentive to the European Commission’s negotiations with Greece and tensions in the Middle East. But these political and geopolitical issues have failed to overshadow the macroeconomic momentum.


Eurozone growth forecasts are revised upward.

Eurozone growth forecasts for 2015 have been revised upward by the major international economic organisations, particularly for Germany and Spain, which are expected to expand 2.3% and 2.7% respectively. Growth estimates predict an expansion of 1.5% in the eurozone and 3% in the United States. This year, the global economy will grow 3.2%, in terms of purchasing power parity.

Inflation hit bottom in core regions.

The data from March reveals that inflation may have bottomed out in core regions, now that commodity prices – particularly oil – have stabilised. However, prices are expected to rise very slowly this year, and there are downside risks if the recovery is interrupted by external factors.

Monetary policy continues to be very flexible.

In this climate of low prices and upward growth, though still below potential, the global monetary policy – with some exceptions – remains flexible and accommodating. The European Central Bank has delivered on its commitment to stimulate the economy, and since the launch of its quantitative easing programme, the ECB has bought Eurobonds at the stipulated target rate.

The US Federal Reserve will raise rates this year, but is not expected to do so before June, and will more likely do so later, well into the second half of the year. This is because the US economy has not yet shown the steady growth necessary to normalise rates; it is expected to achieve this growth rate in the next quarter, but the Fed relies more on activity and employment data than on economic confidence figures. The latest employment data was fairly disappointing, which may induce the Fed to be particularly cautious with the initial interest rate hike. The normalisation process is likely to occur very gradually; as we know, it is not in the interest of the Fed to assume excessive risks that could jeopardise the economy and the markets.

In the United Kingdom, in light of falling inflation and the recent slowdown in an economy that, nevertheless, maintains good growth rates, no interest rate hikes are expected until after the Federal Reserve has done so.

Monetary assets remain at minimum levels…

In this scenario, the rates offered on deposits and monetary assets remain very close to zero. However, inflation in Spain remains negative, allowing us to maintain purchasing power in real terms, even at very low rates.

… and there are increasingly fewer opportunities in sovereign bonds.

With regard to bonds, impending rate hikes in the United States will trigger an increase in interest rates on American Treasury bonds with the corresponding drop in prices. We therefore do not recommend investing in sovereign bonds in dollars. In Europe, the ECB’s asset purchasing programme has brought interest rates on high credit-quality bonds to a minimum, with 10-year German bonds yielding 0.2%. We therefore see little value in government bonds from the eurozone’s central countries.

Though there is still value in longer-term peripheral bonds .

In terms of debt for peripheral eurozone countries, short terms – up to two years – are at minimums, and although they compare favourably to Germany’s negative rates, in absolute terms, they offer negligible returns that do not outweigh the rate risk. More value can be found in long terms, especially in Spanish, Italian and Portuguese bonds that are supported by the ECB’s flexible policy and purchase programme.

In general, corporate bonds insufficiently remunerate the risk, though there are some opportunities


in the high yield category.

In corporate bonds, we must differentiate between high credit-quality bonds and high yield or lower credit-quality bonds. The former offer relatively unattractive yields because the risk premiums are too low, making prices very sensitive to movements of the base curve, meaning, the yields on sovereign bonds. For that reason, we see little investment opportunity in this type of asset. Lower credit quality – or high yield – bonds offer better spreads with regard to sovereign curve rates, in addition to the fact that default rates will remain at sharply reduced levels. However, given the greater risk inherent in this type of asset, we would recommend short-term investments in highly diversified portfolios.

Equities continue to be the best investment option this year. Although indices have already risen sharply in the eurozone, we remain positive…

We continue to believe the year’s best investment opportunities lie in equity markets, despite the fact that indices have already risen sharply, especially in the eurozone, and have begun to approach levels above the average of recent decades. Nevertheless, the improvement in the economic outlook and the competitiveness resulting from the depreciation of the euro should continue to precipitate advances in corporate earnings, and eventually justify increases in the valuation multiples of companies. This, coupled with the expansionary policy of the European Central Bank and the sustained rise in dividends paid to shareholders, signifies further increases for European markets.

… though market corrections could be generated.

There are risks, however, that could prevent the European indices from continuing to rise: some have more to do with politics (elections, the Russia-Ukraine conflict) than the economy, but others have to do with the need for companies to confirm sustainable improvements in corporate profit and revenues. Thus, it is possible that market corrections may be generated at some point, which could be a good buying opportunity if we trust that European companies, like their American counterparts, will return to pre-crisis profit levels.

We see more value in the United States and Asia.

In the United States, valuations are still more demanding than in Europe, though we continue to believe the market has value because American companies have a strong ability to generate profits and revenues, and because, at times of risk aversion, it is more resistant to declines than other more cyclical markets, like those of Europe. In emerging economies, we maintain our positive view of the Asia-Pacific and a position in these regions that should continue to provide value to our portfolios because market valuations are attractive and the economies of these countries are in the process of expansion.

We will trim the weight if markets rise much more.

Finally, we want to clarify that, though we remain positive about the evolution of equities, we do not rule out trimming the weight of these assets if markets rise much more.

Currencies will stabilise at current ranges, though the dollar may continue to rise.

In currencies, the sharp correction in the price of the euro in key cross rates seems to have stabilised, although we think more movement may yet occur, especially against the US dollar, which we will continue to position around 1.05-1.10 in the short term. We expect more stability against the pound in the coming weeks since uncertainty about the upcoming general elections in the United Kingdom will ensure that the pound does not take advantage of monetary policy differences between its country and the eurozone. We see similarities with the yen in terms of stability since, for the time being, the two monetary policies have a comparable tone.


We expect commodity prices to rise, but we remain cautious and patient.

With regard to commodities, we remain cautious and patient. We expect oil will continue trending upwards to $70-80/barrel, but in the short term, volatility will continue. The forecast for gold continues to be negative, with the dollar gaining strength and rate hikes looming in the US. Industrial metals will recovery when we see a strong rebound in the Chinese economy and other major emerging economies; for the moment, we reserve our opinion about the latter asset class.


Equity Indices IBEX35 (3 years)

Euribor Euribor 12 months (3 years)

EUR/USD (3 years)

10 years government yields

Currencies

Government Bonds

Corporate Bonds (1 year spread)

Commodities

Data: Bloomberg


Equity Indices performance (3 years)


Important Remark:

This contents of this document are merely illustrative and do not pretend, are not and cannot be considered under any circumstances as an investment recommendation towards the contracting of financial products.

This document has only been prepared to help the customer make an independent and individual decision but does not intend to replace any type of advice needed for the contracting of such products.

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Consequently, March Gestión de Fondos, S.G.I.I.C., S.A.U. and its customers are not bound by this conditions concerning the final documents to be approved. March Gestión de Fondos, S.G.I.I.C., S.A.U. does not offer any guarantee, expressly or implicitly, in relation with the information shown in this document.

All terms, conditions and prices contained in this document are merely informative and subject to modifications depending on the market circumstances, changes in laws, jurisprudence, administrative procedures or any other issue which may affect them. The customer should be aware that the products mentioned in this document may not be appropriate for his/her specific investment targets, financial situation or risk profile. For this reason the customer must make his/her own decisions by taking into account such circumstances and by obtaining specialized advice in tax, legal, financial, regulatoy, accounting issues or any other type of information required.

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Please note this document has been translated for your information only. In case of any errors or misinterpretations, the Spanish text will always prevail.

the scottish enlightenment: the silver bridge between newton … · 2015-01-05 · onthly strategy...

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