Union Investment retains neutral risk positioning
Equity weighting remains neutral
Risk positioning remains at level 3 (RoRo meter)
At its first meeting of 2019, the Union Investment Committee (UIC) confirmed its neutral risk positioning and left the RoRo meter unchanged at level 3. This main reasons for this decision were the current weakness of economic momentum combined with the changed, more dovish tone of major central banks, such as the US Federal Reserve (Fed) and the European Central Bank (ECB). Political uncertainties, including the ongoing trade dispute and the unresolved issue of Brexit, are further reasons for a neutral stance.
The UIC does not yet see the strong movements of risk asset prices over recent weeks as an indication of a significant shift in macroeconomic conditions. The economic cycle is still at a late stage, the political situation is fragile and the fundamental business-side pressures on companies are increasing. Rather, the recovery since the start of this year is believed to be linked to the heavy sell-off in the final weeks of 2018 and can be interpreted, to an extent, as a rebound. What is new, however, is the more moderate tone of the central banks. A number of statements (in particular from the Fed) have recently indicated greater acknowledgement of the weakening economy and willingness to take supporting measures and/or forego tightening if necessary. As a result, the Fed has called a kind of ‘soft put’ that should provide support for the capital markets in the coming weeks and months. But at the same time, this mechanism works in the opposite direction and thus limits upside potential. After all, the central bank is likely to return to its original course (of tightening) if the economic picture improves radically.
Economy, growth, inflation
The UIC still does not expect the global economy (or major regions such as the US, Europe or China) to slip into recession in 2019. But economic activity has recently tapered sharply. There are many different reasons for this, ranging from industry-specific issues (especially in the automotive sector) to weather effects and the weakness of global trade. Germany’s poor industrial output in the fourth quarter of 2018 was a visible sign of this stagnation. At macroeconomic level, however, the UIC does not consider this weakness to be so pronounced that it will drag individual economies into recession. After all, robust labour markets (not only in the US, but also in Germany) and high wage settlements are leading to a rise in real incomes and thereby stabilising consumer spending. The US housing market appears to have rallied again and is factoring in the lower interest rates at an impressive pace. This shows how important the central bank’s verbal interventions are, not just to the markets but to the real economy too. They probably prevented a greater slump in investing activity in major industrialised countries.
Consequently, the UIC anticipates a slowdown in the rate of growth but not a recession. In this environment, the economists at Union Investment have lowered their 2019 growth forecasts to 0.9 per cent for the eurozone (previously: 1.7 per cent) and 0.6 per cent for Germany (previously: 1.5 per cent). This is assuming that the United Kingdom does not leave the EU without a deal in place. There is currently no sign of a breakthrough in the stalled Brexit negotiations, however. The US growth forecast is now 2.4 per cent (previously: 2.5 per cent), compared with 2.8 per cent in 2018. The forecast has thus been lowered to a much lesser degree than on this side of the Atlantic. This is because the US economy has a far stronger domestic focus and is much more immune to deteriorating conditions elsewhere, although it cannot escape entirely unscathed.
Charts of the month: Slump in industrial output, deterioration of financing conditions in the US financial market
Fixed income: carry segments significantly increased
Monetary policy of the central banks becoming more cautious
In December, the Federal Reserve implemented its fourth interest-rate rise of 2018. Going forward, the US central bank will be guided more heavily by the data. There are currently many indications that the Fed will maintain its course in 2019, albeit at a markedly slower pace. Given the current economic weakness, the UIC does not expect key interest rates to be raised in March. Over the year as a whole, the Fed is likely to put up interest rates twice at most. The UIC also predicts a more cautious approach by the ECB. In the UIC’s view, the central bank is still aiming for normalisation of its monetary policy. However, the combination of political risks and weak economic activity is likely to prevent it taking any steps in this direction for much of 2019. The UIC expects long-term refinancing operations to pick up in the spring. An initial deposit-rate hike is unlikely until late 2019, while an increase in the base rate itself is not expected until 2020.
Fixed-income carry positions increased
The more gradual raising of interest rates by the Fed and ECB will limit the upside potential of core yields. The yield forecast for ten-year US treasury notes has been reduced to 2.8 per cent for the end of 2019, while ten-year German Bunds are expected to yield 0.6 per cent. Activity in the primary market for credits picked up significantly at the start of the year. The majority of issuers came to the market with attractive premiums, although this led to repricing in the secondary market. At their current spread level, corporate bonds are valued slightly more fairly again. The UIC expects spreads to remain within a narrow range over the course of 2019. It believes EM government bonds have regained their appeal (the Fed’s soft put, the US dollar’s depreciation against EM currencies, stabilisation of commodity prices, more attractive valuation levels).
Equities underweighted on the whole
Following their significant correction in December, the equity markets have been staging a recovery since the start of the year, primarily due to the Fed’s more moderate tone (soft put). With the economy in a late-cycle phase, analysts have lowered their profit estimates for the first half of 2019. Medium-term expectations are still too high and will have to be adjusted as the year goes on. The upside potential of this asset class is therefore limited, especially as an improvement in the economic data going forward would likely prompt the Fed to reconsider its more dovish stance.
Industrial metals and energy supported by good fundamentals
The curbing of production by OPEC and Russia and the diminishing level of drilling activity due to lower prices are starting to take effect, and oil prices have rallied sharply. The fundamental environment is still positive. If supply decreases slightly and demand increases over the course of the year, the market should regain its equilibrium and, in the second half of the year, should see inventories fall again. The environment for industrial metals also remains benign. In particular, inventories of copper and nickel have continued to decrease of late. Following the strong rise in the price of palladium from mid-2018, the global weakness of the automotive industry is now increasingly posing a risk for this precious metal.
Yen serving as a safe haven
Following the correction of the US dollar/Japanese yen exchange rate, the UIC is establishing a position in this currency pair. The fundamental factors depressing the US dollar (a slight slowdown in US economic growth and a growing fiscal deficit) have been compounded by the less hawkish stance of the Fed in recent weeks.
Convertible bonds more buoyant
Over the past four weeks, prices for global convertible bonds have risen significantly. The average equity sensitivity advanced from around 41 per cent to 44 per cent due to the easing situation in the global equity and credit markets. US paper increased the most, climbing by 5 per cent. The other regions also benefited from the positive market conditions. Overall, volatility at individual security level was still up significantly. The primary market slowly got back into action in the first half of January. An issue from China’s Lenovo, with a volume of US$ 675 million, was the biggest of the year so far. The market as a whole continues to be attractively priced overall. However, a number of oversold bonds have seen heavy demand again in the year to date.
Our portfolio holdings
Unless otherwise noted, all Information and illustrations are as at 22 January 2019.