The stock markets are rising and investors are smiling. June closed positively for stock exchanges around the world, especially for those in America (significantly more) and in Europe (with slightly more caution), marking the best figures since the beginning of the year.
The US S&P 500 index rose by over 3.5% compared to May and the European area index Stoxx 600 (which includes 600 of the main European market capitalization companies) closed the month up (+2 %) and recorded the highest values of the last year.
To what do we owe this enthusiasm?
To close the month with a decisive upwards turn and an obvious sigh of relief, we owe our thanks to two main events; one is related to the trade war between the US and China and the other to developments in Europe:
- Trump and Xi Jinping: they shook hands and established an important truce in the ongoing trade war.
- In Europe, the President of the European Central Bank, Mario Draghi, stated that a new phase of Quantitative Easing may soon begin.
To effectively explain why these two events have positively impacted the markets, it is necessary to take a step back and shed light on what we mean precisely by "trade war" and "quantitative easing".
1.The Trade War
It has been almost a year since the start of the trade war between the US and China. A war whose consequences on the economy of both countries involved, as well as on people's daily lives, has demontrated how truly devestating they can be. In practice it works like this: one country (the US in this case) imposes commercial duties on another (China). The duties are commercial taxes that the exporting country must pay to the importing country before it can sell its goods there.
In the case of trade war between the US and China the duties were levied on a wide variety of goods (steel and hi-tech, above all, but also consumer goods), and were very heavy; reaching 25% of the value of the exported goods.
This measure, which more often than not reduces the flow of trade, has two consequences for the exporting country (in this case both China and the USA, given that Beijing has responded to American duties in kind).
- The first is obviously economic, as the exporting country must pay substantial tax amounts to the importing country.
- The second is commercial. To recover the amount spent, the exporting country must raise retail prices, the result being that its products are more expensive and, therefore, less competitive on the market.
Now, after months of uncertainty and constant skirmishes between China and the United States, after the (heavy) commercial repercussions on both sides (which have seen prices rise by as much as 25%) the US president and the Chinese president have finally shaken hands at the Osaka summit and appear to have arrived at a truce.
A détente that, as well as giving new life to the economy, made up of goods and sales, is fortunately also having positive effects on the financial markets.
The first time Mario Draghi started Quantitative Easing, in 2015, the press wrote that it was a "bazooka against the crisis". That statement, in part, is absolutely true. And, in a sense, if the euro zone can be said to have emerged from the terrible crisis that began in 2008, much of the credit goes to Draghi and his "bazooka".
What is it actually about? It is an extraordinary cash injection into the markets. In practice, the European Central Bank takes on the responsibility of purchasing all the government bonds that remain unsold at the monthly auctions (in the past, the ECB has even acquired 80 billion a month), so as to avoid there being any unpurchased securities.
In this way two results are obtained
- The first is the stabilization of the value of government bonds (so as to avoid speculation), and avoiding the default of some States whose securities are considered unattractive by investors (with all that it follows in terms of spread).
- The second result is to offer a parachute to the commercial banks, so that they can, again, finance businesses and families, thus stimulating consumption and ensuring that money is invested in the real economy.
It is, as one can well imagine, a very effective measure that the central banks implement to avoid or solve crises (as in 2015) or economic stagnation.
Since the European economy is still recovering, it is vulnerable to the negative effects of political uncertainty (such as that surrounding Brexit and the current political fragility of the European parliament). The reemergence of quantitative easing and political uncertainty are translating into potential financial uncertainty.
The markets, at least for now, can sleep peacefully.
Oval does not provide financial advice. If you need further information we suggest you look for expert advice.