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Union Investment reaffirms neutral risk positioning

UIC raises equity weighting slightly

Risk positioning remains neutral, RoRo meter at level 3

RoRo meter at 3

The Union Investment Committee (UIC) reaffirmed its neutral risk positioning (RoRo meter at 3) at its regular meeting on 24 March 2020. At the same time, the committee increased the equity weighting slightly. The existing overweighting of (investment-grade) corporate bonds and of government bonds from the eurozone’s periphery was confirmed.

The UIC believes that the monetary and fiscal policy measures being taken are an important tool in tackling the economic consequences of the coronavirus pandemic. For the time being, these measures have effectively addressed the risk of the turmoil in the real economy spilling over into the financial sector. Both the liquidity support and the lowering of solvency risks reduce the threats for the banking sector and thus reduce financial market stress and systemic risks. However, a broad-based and sustained uptrend would require an improvement in economic activity that, in turn, would require a slowdown in the number of infections.

In this situation, the UIC continues to be in favour of (fixed-income) investments that benefit directly from the central banks’ support. Conditions have also improved for equities, although there are even greater imponderables here. What will happen in the US is particularly uncertain. The UIC continues to believe that trading in the capital markets will remain turbulent in the short term. But the medium- to long-term prospects are positive.

Global growth forecasts lowered

In view of the coronavirus pandemic, the economists at Union Investment have significantly lowered their growth forecasts. Public life has temporarily been suspended in many industrialised economies (especially in Europe and the US) in order to stem the outbreak. 

However, this is likely to cause an economic slump in the first and second quarters of 2020. The government support measures will not really be able to prevent this, but should mitigate negative second-round effects. The economy should then start to recover in 2021.

The gross domestic product (GDP) of the European Monetary Union (EMU) is expected to decline by 3.6 per cent this year (previous estimate: growth of 0.8 per cent). Italy, the country currently reporting the highest infection levels outside China, is likely to be hit particularly hard. We also anticipate a recession in Germany. In 2021, we expect growth rates to return to positive territory. The US economy will probably suffer a further significant slowdown in the second quarter of this year. However, US growth was very robust until recently. We therefore expect GDP to fall by 1.9 per cent for 2020 as a whole (previous estimate: growth of 1.6 per cent). The US economy should also see a return to growth next year.

Charts of the month: Federal Reserve (Fed) and European Central Bank (ECB) significantly expand their purchase programmes

Total assets on the Fed’s balance sheet (US$ billion); ECB's monthly net purchases (€ Billion)
Charts of the month
Sources: Bloomberg, Union Investment, as at 23 March 2020.

Monetary policy: central banks take rapid and extensive action

The major central banks have adopted aggressive measures. On 23 March, the Federal Reserve, for example, announced unlimited quantitative easing – including corporate bond purchases – and extensive support to ensure the flow of credit to the real economy. The Fed had already decided to cut interest rates by 100 basis points and expand its bond-buying programme.

The European Central Bank has also said that it will step up its securities purchases. An additional purchasing volume of €750 billion is planned under the new Pandemic Emergency Purchase Programme (PEPP). The ECB Governing Council emphasised that it would do “everything necessary” and, if required, would adjust the size, duration and composition of the programme.

The central banks’ swift and far-reaching action in response to the market turmoil helps to reduce pressure within the financial system. This is absolutely necessary in order to create stability in the capital markets (especially in the credit segment) and also lays the foundations for a quick and robust economic recovery. Combined with sizeable fiscal emergency programmes implemented by many governments, this action offers significant support for the financial sector and the real economy, but it will not be enough to bring about a lasting turnaround in this crisis.

Equity weighting within the asset classes

Overweighting in spread products unchanged – covered bonds further reduced

The coronavirus pandemic and subsequent containment measures triggered a sell-off in the market for spread products as investors sought refuge in safe havens. With the implementation of fiscal stimulus and monetary policy measures, the credit markets should now bottom out. These measures will also raise government debt levels in the affected countries significantly. This should prevent a further persistent fall in yields on Bunds. EM and high-yield bonds are likely to benefit indirectly from the measures but are also subject to increased idiosyncratic and economic risks.

Slight overweight exposure to equities from industrialised countries

Sweeping actions taken by governments and central banks have halted the sell-off in the equity markets and first signs of a turnaround are emerging. Volatility has started to come down, albeit from a very high level. But it is still too early to tell if the worst is over. Nevertheless, justified hopes of increasing stability are returning to the equity markets thanks to the fiscal and monetary policy stimulus measures. The stock markets will remain volatile in the near term, but equities remain attractive on a medium-term horizon.

Overweight position in precious metals

Our overall view of the commodities markets remains neutral. Within the asset class, precious metals are among our favourites. Gold recently came under pressure despite its status as a safe haven. This was because precious metals were easier to liquidate than other assets and thus experienced a sell-off. The stabilisation in the credit markets should help to ease the selling pressure in this segment. Real interest rates in the US are also falling again, which should create an added tailwind. In addition, South Africa has now also suspended economic activities to a large extent and has closed all mines for the time being to fight the spread of coronavirus. South Africa is the largest producer of gold and platinum. The oil market is still recording significant excess supply.

No changes to currency positions

Pound sterling depreciated steeply against the euro as a result of the UK government’s lax approach to the coronavirus crisis. The cost of the pandemic for the UK is likely to be very substantial. We will retain our wait-and-see approach for now. The same applies for the US dollar. The anticipated package of measures to support the economy will leave a large hole in the US federal budget and will probably weaken the US dollar in future. But demand for the currency was recently strong as many issuers were taking out debt in US dollars. We expect that volatility will remain high.

Convertible bonds in crisis mode

As stock markets around the world continued to plunge, global convertible bonds were also weakening noticeably. However, the segment’s equity market sensitivity has fallen significantly (from around 50 per cent to just under 30 per cent). As a result, losses in the market for convertible bonds only came to about a third of those in the equity markets, demonstrating the benefits of the convexity of this asset class. Prices of convertible bonds fell significantly across all regions. 

Our positioning

UIC

Unless otherwise noted, all information and illustrations are as at 24 March 2020.

Market news and expert views

Market news and expert views: March

Economy, growth, inflation and monetary policy – the monthly report ‘Market news and expert views’ will keep you informed about the latest developments and our expert assessments. It will also give you a comprehensive review of and outlook for the relevant asset classes.
(As at 3 March 2020)