UIC reduces risk in April for tactical reasons
Optimism about growth largely priced in to the markets
RoRo meter remains at 4, moderately bullish risk positioning
At its latest regular meeting in April, the Union Investment Committee (UIC) reaffirmed its moderately bullish risk positioning (RoRo meter at level 4) for a further month. It also decided to halve tactical cash holdings (held at negative interest rates, down by 2.5 percentage points) and in return to bulk up absolute return investments. The model portfolio thus continues to be tilted towards the absolute return asset class as well as equities and government bonds from the eurozone periphery, while remaining significantly underweight in safe havens. The exposure to the commodities segment is again neutral.
The UIC had already made a number of adjustments over the course of April. For example, in response to the widening valuation gap, it had initially switched a portion of its overweight in equities from the industrialised countries to the emerging markets. The overweight exposure to equities from the developed markets and in EM government bonds was then neutralised in the middle of the month. At the same time, the UIC closed out its currency position in the euro against the Japanese yen as well as the underweight position in investment-grade corporate bonds. The underweighting of government bonds from the core eurozone countries was increased. These changes had the effect of increasing not just the absolute return position but notably also the liquidity position. The cash position has now been significantly reduced following the adjustment made at the regular meeting in April.
The UIC is maintaining its constructive outlook. Risk assets continue to be bolstered by progress in efforts to combat the pandemic, improvements in economic conditions and the sustained and in some cases expanded level of support from monetary and fiscal policy measures. Moreover, the negative impact resulting from the rise in yields has waned as expected and companies are posting extremely strong results in the first quarter reporting season. However, the absence of positive price changes in response to the healthy data on the corporate and economic front shows that the optimism about growth is already largely priced in for all asset classes. This is backed up by the investor positioning and sentiment indicators that are used by Union Investment, which are no longer generating any additional purchase signals after being on an upward trajectory in recent months.
In the coronavirus pandemic, levels of infection, containment measures and progress with vaccination campaigns are taking increasingly divergent paths. Whereas a ferocious new wave of infections is hitting India particularly hard, the tightening and easing of lockdowns in continental Europe (e.g. nationwide ‘emergency brake’ in Germany, easing in the Netherlands) are more or less balancing each other out. Meanwhile, experts believe that the US and the UK are now relatively close to achieving herd immunity thanks to their high-speed vaccination campaigns and the high case numbers that they experienced last year.
Economy under the influence of the coronavirus crisis
The economy remains under the influence of the coronavirus pandemic and the resulting measures being taken by governments. Because of the progress being made on various fronts – accelerated vaccination campaigns, a quicker return to normal economic life and vast government relief packages – Union Investment’s economists have once more significantly upgraded their US growth forecast. They now expect the US economy to grow by 6.4 per cent this year – instead of 5.5 per cent as previously forecast.
In the eurozone, the higher infection rates and the resulting restrictions on social contact are putting the brakes on the economy for longer than had been anticipated. However, the UIC remains confident that there will be an initial easing before the second quarter is out. Looking further ahead, the recent increase in the pace of the vaccination campaigns has somewhat brightened the outlook for the second half of the year. Those sectors of the economy that have been heavily restricted up to now should then be able to open up for business again. Stronger impetus from foreign trade will bridge the gap until that time and is staving off a more pronounced economic slump. In this respect, Europe is benefiting from the success that its key export markets, the USA and China, have had in fighting the pandemic. Germany’s export-oriented economy in particular is receiving a substantial boost to demand. The economists at Union Investment have thus raised the growth forecast for the eurozone from 4.9 to 5.1 percent for 2021, and from 5.2 to 5.3 per cent for 2022.
The UIC is not anticipating any sustained inflationary pressure in either the eurozone or the US. Although inflation rates are likely to rise in both these major economic areas – significantly at times – this will mainly be due to one-off factors and comparison with the low base of the prior year. Peak inflation for the year will be reached at different times though. Whereas the rate of price increases in the US will be at its maximum in the first half of 2021, the low-base effects in the eurozone are not expected to top out until the fourth quarter. Here, too, however, the statistical effect will have run its course by the beginning of 2022.
Monetary policy: a steady hand
As expected, the European Central Bank (ECB) did not announce any changes to its monetary policy approach at its meeting in April. The bank took the view that the short-term economic outlook had deteriorated somewhat across the eurozone due to the continuing COVID-19-related lockdowns. However, this was offset by an improved outlook for growth. All in all, the ECB made a very conscious effort not to sound more optimistic than in March, in order to defuse speculation about potential tapering plans. It emphasised the uncertainty caused by the pandemic and reiterated its view of the upturn in inflation as a temporary phenomenon. The ECB also expressed its satisfaction with the purchase volume under the Pandemic Emergency Purchase Programme (PEPP), which had been increased in March. However, it did not provide any further information on the future trajectory of purchase volumes or plans for the programme beyond March 2022. These important decisions will be made from June onwards.
The meeting of the US Federal Reserve’s Federal Open Market Committee (FOMC) did not provide a great deal of new insights either. As expected, the Federal Reserve (Fed) did not change its monetary policy strategy either Fed Chair Jerome Powell seems to have managed to dispel concerns about tapering plans once again, at least temporarily However, if the coming months bring the expected marked decline in unemployment coupled with significant improvements in key labour market metrics such as non-farm payroll employment, the Fed might start to gradually scale back its bond purchases slightly earlier than previously anticipated by the UIC (in the first rather than the second quarter of 2022). In this case, preparatory communications about tapering would be expected from late summer 2021.
Coronavirus: US and UK on the verge of herd immunity
Percentage of the population with immunity to COVID-19
Equity weighting within the asset classes
Bonds: strong demand for investment-grade corporates
Following steep increases in previous months, yields on ten-year US government bonds consolidated in April. Over the course of the month, yields fell from just under 1.75 per cent to a temporary low of less than 1.55 per cent, but subsequently picked up again in light of the latest relaxation of coronavirus-related restrictions. Yields on ten-year Bunds continued to rise at a slow pace to around -0.25 per cent in line with the UIC’s expectations. The general upward pressure on yields is likely to persist in the coming months. By the end of the year, the committee expects ten-year US Treasuries to be yielding 1.9 per cent and ten-year German Bunds to be yielding 0.0 per cent. Yield spreads widened slightly in the eurozone periphery in recent weeks but continued to contract in other carry segments. Investment-grade corporate bonds traded at the lowest spreads in three years at index level (ER00), which reflected both the solid state of the corporate sector and high demand from investors. The UIC believes that the potential for spreads to narrow further at index level is relatively limited. Government bonds from the eurozone periphery will offer the greatest opportunities in this respect over the coming months.
Equities: strong reporting season
The upward trend in the equity markets of industrialised countries continued in recent weeks, although some indices – such as the DAX – were showing the first signs of fatigue. This also filtered through to the various positioning and sentiment indicators analysed by Union Investment, which on aggregate now suggest no better than a neutral picture overall. Alongside the slowdown in yield growth and positive macroeconomic data, corporate results for the first quarter of 2021 took centre stage. But even though most results continue to exceed the already heightened expectations by a decent margin and thus provide some headroom for equity market valuations, the reporting season has so far not stimulated further broad-based share price growth in the short term. Following a correction in the first quarter, equities from the emerging markets stabilised in April – despite concerning spikes in coronavirus cases in some regions and countries (especially India) – and are currently one of the UIC’s tactical favourites.
Commodities: continued preference for energy assets
At its latest meeting, OPEC confirmed plans for production increases. Over the next three months, crude oil production will be ramped up by two million barrels per day. The organisation anticipates a rise in demand for oil, driven mainly by the relaxation of coronavirus-related restrictions in Europe and growing demand for petroleum in the US. The cartel believes that these factors should more than outweigh a potential major decline in demand from India due to the spike in coronavirus infections in the country. At the same time, the UIC remains convinced that, in the commodities segment, the energy sector is the number one beneficiary of the economic reopening. Roll yields also remain attractive at around 3 per cent. By contrast, the committee believes that the upward potential of industrial metal prices has been all but exhausted. With the exception of copper, supply of all key industrial metals is likely to outstrip demand in 2021. These market surpluses coincide with weakening credit-led demand from China, which further limits the scope for price increases. The situation in the market for precious metals remains unchanged: Platinum and palladium are the UIC’s favourites as they are likely to remain in demand due to the automotive market getting back into gear. The price of gold will continue to be influenced strongly by the trajectory of US real interest rates and the US dollar.
Currencies: opportunities and risks in balance
In light of the steeper rise in yields on US Treasuries compared with other government bonds, the Biden administration’s resolute fiscal policy measures and the significant advances in tackling coronavirus in the US, the US dollar appreciated in the first few months of the year. But in recent weeks, the greenback weakened again after positive US news had been largely priced in and the upward trend in US yields petered out. The expected increase in the availability of vaccine doses in continental Europe means that the euro has further potential to catch up. But in the near term, economic news from the US is likely to be much more upbeat than east of the Atlantic. The depreciation of the Japanese yen also slowed due to support from the consolidation of bond yields in April. It was only with the latest set of economic data that the euro started to appreciate against the Japanese yen once again. Consolidation is also the overriding theme for pound sterling. The brisk rollout of vaccinations in the UK had prompted the currency to appreciate strongly against the euro. But as vaccination programmes in the eurozone are gathering pace, the UK’s lead is likely to shrink in the coming weeks. In addition, the Scottish Parliamentary elections on 6 May come with a looming event risk because they will provide an indication of the appetite for another independence referendum.
Convertibles: a positive month
After a slump in March, convertibles picked up again in April. All regions performed well, with the exception of Japanese convertibles, which weakened slightly in recent weeks. In light of the positive performances, equity sensitivity increased to 57 per cent while valuations remained stable. New issues were brought to the market in all regions. The Asian primary market even saw a large-scale transaction with an issue volume of US$ 3 billion, which was placed by Meituan.
Unless otherwise noted, all information and illustrations are as at 29 April 2021.