Union Investment retains neutral risk positioning
Overweight position in equities from industrialised countries
Risk positioning remains at level 3 (RoRo meter)
At its latest regular meeting in March 2019, the Union Investment Committee (UIC) kept the RoRo meter at level 3 and thus confirmed its neutral risk positioning. This decision was taken as a supportive monetary policy outlook and uncertain macroeconomic prospects are keeping the markets in a delicate balance. Major central banks – above all the US Federal Reserve (Fed) – have performed a policy U-turn and moved away from their original roadmaps for a tightening of monetary policy. The UIC therefore anticipates no further interest-rate hikes this year, neither in the US nor in the eurozone. However, this market-friendly change of tack is being partially counteracted by the overall economic picture. Early indicators suggest that growth is picking up again after the most recent weak phase, but economic data is not (yet) showing a substantial improvement across the board.
Nevertheless, the UIC is maintaining its assessment that the positive phase of the global economic cycle is not yet coming to an end. Further in the future, economic growth should regain momentum – boosted, among other factors, by monetary (Fed, ECB) and fiscal (China) policy measures. On this basis, the committee is increasing the equity quota slightly. In the fixed-income segment, the UIC is taking profits on positions in corporate bonds from investment-grade borrowers. The freed-up liquidity is being used to mitigate the underweight exposure to government bonds form core eurozone countries. However, there will not be much upward pressure on yields in light of the revised monetary policy outlook and persistently low levels of inflation.
With regard to Brexit, the UIC still expects that an agreement will be struck at the last minute, i.e. it is not using a no-deal exit of the UK from the EU as a baseline scenario. But events in recent weeks have shown that the situation is chaotic and in deadlock. A hard Brexit thus remains a marginal risk. However, this eventuality has already been priced in by the capital markets, at least in certain asset classes. Pound sterling is a case in point, at least to a much greater extent than the euro. The UIC is therefore maintaining the long position in sterling in anticipation of an appreciation of the currency against the euro.
Economic data presents a mixed picture
Current economic conditions are remarkable in more than one way. For example, leading indicators for the manufacturing sector and news from the service sector point in very different directions: the industrial sector appears to be struggling, while the service sector seems surprisingly stable. In addition, there are also major geographical discrepancies. Europe, and especially Germany’s export-oriented economy, are particularly hard hit.
Looking ahead, the UIC does not believe that the positive phase of the economic cycle is already at an end. In fact, certain data points (e.g. most recently the ifo Business Climate Index) suggest that the economy might be bottoming out. Our proprietary leading indicators are showing particularly strong signs of a turnaround. Our barometers for the US (ULI), the eurozone (ELI) and China (CLI) have all reversed and started to climb again. The UIC expects that this upward trend will continue. But in view of the depth of the current weakness in the economy, it will not take a more bullish positioning until this assessment is confirmed by further evidence. The committee further expects that the extensive economic stimulus package adopted by the Chinese government (with a total volume of more than 4.5 per cent of the country’s GDP) and the relaxation in monetary policy (in connection with the improved financial conditions) are going to provide additional support for this trend.
Charts of the month: spreads on European credit instruments narrow, profit revisions stabilise
Taking profits on investment-grade corporate bonds
Central banks change tack
Major central banks performed a policy U-turn in recent weeks. In all probability, the Fed will abstain from further interest-rate hikes for the rest of the year – for the first time since 2014. In Europe, the ECB’s purchase programme for new bonds was terminated at the end of 2018. Originally, the bank had also planned to bring negative interest rates on central bank deposits to an end in 2019. However, this plan was scuppered by the recent slump in economic growth. In the best-case scenario, the UIC expects the first deposit-rate hike by 0.15 per cent to take place in March 2020 at the earliest, followed by just one further upward move by 0.25 per cent in the summer of 2020.
Taking profits on corporate bonds from investment-grade borrowers
The continuation of expansionary monetary policy, the persistent weakness of economic growth and a residual risk of a hard Brexit continue to weigh on yields on safe-haven government bonds. Yields on Bunds recently dropped back into negative territory, even on 10-year paper. An underweight exposure to safe-haven paper – i.e. government bonds from eurozone core countries and covered bonds combined – is not advisable in this environment. Based on past experience, it can be expected that covered bonds will follow the same trend as these government bonds, but with some delay. Since the Fed’s verbal U-turn on monetary policy at the start of the year, spread segments have been performing very well. The bulk of the potential has thus been unlocked.
Overweight position in equities from industrialised countries
The upward momentum in the equity markets started to slow a little in March. The UIC takes a positive view of the fact that earnings expectations have stabilised following a series of downward profit revisions in recent months. For the first quarter of 2019 in particular, adjustments seem to have come to an end and most companies should now be in a good position to meet or even exceed profit expectations. Investor sentiment has also improved significantly and is now in positive territory. Despite improvements in the overall environment, we are not taking a very bullish position just yet. Interest rates should remain low based on recent central bank decisions. This will create an additional tailwind for the corporate sector. The UIC favours equities from industrialised countries over EM equities, because the latter are still affected by very weak leading indicators and a downward trend in profits.
Neutral overall exposure to commodities
Following significant gains in the year to date, Union Investment’s experts believe that most commodities have reached their price targets. Investors are therefore positioned fairly moderately. Further price increases seem unlikely until a sustained upward trend in economic growth materialises. In the energy commodity sector, forecasts of demand recently dropped a little in view of weaker macroeconomic data. But OPEC production levels reduced by a similar amount due to sanctions and production cuts in Saudi Arabia. Precious metals present a split picture. The price of palladium began to stall after weeks of steady gains, whereas gold became more attractive as a result of the tentative behaviour of central banks.
Pound sterling remains overweighted relative to the euro
Irrespective of the outcome of the Brexit debate, the pound is likely to strengthen against the euro, because Brexit is now priced in to a much greater extent in the price of sterling than it is in the euro. This creates an asymmetric risk picture: If a deal is struck, the pound should appreciate strongly against the euro. But in the event of a hard Brexit, the euro will also come under pressure at an international level.
Convertible bonds remain on a positive trajectory
Driven by paper from Asia, global convertible bonds strengthened over the past four weeks. US convertible bonds continued their strong performance from recent months and climbed to new highs for the year. Average equity sensitivity increased to just under 50 per cent as a result and valuation levels rose. Overall, the market for convertible bonds is highly convex and pricing is fair to favourable. New issues have been very well received by the market.
Our portfolio holdings
Unless otherwise noted, all Information and illustrations are as at 26 March 2019.