Union Investment retains neutral risk positioning
Overweighting of carry segments
Risk positioning remains at level 3 (RoRo meter)
At its regular meeting on 25 and 26 February, the Union Investment Committee (UIC) maintained its neutral risk positioning. The RoRo meter thus remains unchanged at level 3. At the same time, however, the UIC has identified improvements to a number of key environmental factors, which points to ‘upward asymmetry’ for the capital markets going forward. The committee is therefore opening strategic positions in opportunity-oriented asset classes, particularly in fixed-income, commodity and currency segments.
Four subjects are currently dominating the capital markets: the central banks, the US/Chinese trade dispute, Brexit and the economy. In the UIC’s view, the central banks are not expected to provide any notable stimulus in the short term. The (geo)political factors have recently quietened down significantly. In particular, there are growing signs that a last-minute Brexit deal will be reached – as anticipated by the UIC. The latest developments in the trade dispute between the US and China make further escalation seem unlikely, and this is providing support for the markets. However, the economic data remains challenging. Specifically, the weak economy suggests that taking a position that is (overly) bullish is not a good idea at present, despite tentative signs of stabilisation emerging.
Beleaguered economy, particularly manufacturing
The current weakness is hitting industry especially hard, above all in economies that are heavily involved in global trade. Germany and Japan are prime examples of this combination, and their latest economic data was therefore bleak. In particular, the level of new orders in manufacturing is sounding warning bells. Nevertheless, data for the service sector is still good – even in Germany. The consumer sentiment index of German market research company GfK, for example, held steady at a high level in February. So it is not the case that industry’s weakness is already dragging down the wider German economy. The findings are similar for Japan. Given the diminishing one-off factors (impact of bad weather, sector-specific matters such as the diesel issue) and the easing of geopolitical tensions, the economic prospects are expected to brighten a little in the coming weeks and months.
Central banks signal greater tolerance of inflation
The weak economic data also means that inflationary pressures will increase only moderately this year. Consequently, inflation expectations have recently been significantly lowered again. This effect is boosted by somewhat of a change of mindset among the central banks. There have recently been ever stronger comments from the US Federal Reserve (Fed) and the European Central Bank (ECB) that point to greater tolerance of inflation. The central banks seem to have come to the conclusion that ending their policy of maintaining low interest rates can only be done as part of a very slow and careful process. In January, the Fed clearly stated that its actions would be guided more heavily by the data in 2019 and it would therefore opt for fewer interest-rate hikes than in 2018. And now, there are indications that the ECB is returning to stronger monetary policy stimulus. Given the current softening of the economy, the discussion is centred around issuing new targeted longer-term refinancing operations, as used during the euro crisis. The normalisation of the ECB’s monetary policy would therefore be pushed further into the future and might not even happen at all before the next recession. Against this backdrop, the UIC predicts that the ECB and Fed will continue to take a cautious approach that is closely aligned with conditions in the real economy and in financial markets. Provided that the economy rebounds strongly, this ‘data dependency’ could, later on, increasingly force the central banks to take action again. This is not likely in the coming weeks, however.
Charts of the month: drop in sentiment among purchasing managers, markets have priced out interest-rate hikes by the Fed in 2019
Neutral equity weighting
Fixed-income carry positions increased
The more gradual raising of interest rates by the Fed and ECB will limit the upside potential of yields on German and US government bonds. The prospect of TLTROs is acting as an additional brake on yields in the eurozone. The UIC has therefore again lowered its yield forecast for ten-year Bunds to 0.45 per cent at the end of 2019. With yields on safe government bonds entrenched at a low level for a long period, fixed-income investors are coming under increasing pressure to take on more risk. The marked widening of spreads in the fourth quarter enabled carry segments to regain some of their appeal. As long as the central banks act cautiously and there are no geopolitical ‘incidents’ (trade dispute between the US and China, Brexit), it should be possible to collect the risk premiums.
Prices consolidate at a higher Level
The equity markets have continued to stage a recovery over the past four weeks. This trend is broad-based, as can be seen from the US markets. Above all, the technical key figures have improved significantly. The markets are receiving additional support from companies’ record volumes of share repurchases. Going forward, the performance of the economy will continue to be the main driving factor. In view of the weaker leading indicators, analysts have recently lowered their profit estimates even further for 2019. This year, profits are predicted to rise by just short of 5 per cent at global level. So a profit recession does not look likely at the moment. Equally, the UIC believes that the improved environmental factors remove the risk of falling prices. As sentiment is currently upbeat, the committee is therefore positioning itself on the sidelines for the time being.
Industrial metals and energy remain overweighted
Despite the impressive price rises, the majority of commodities are still attractively valued by historical standards. Energy commodities are likely to see an evenly matched supply/demand situation in the second half of the year due to the curbing of output by OPEC and Russia. US production is expected to be stepped up as the year goes on. Given the attractive valuation, however, the UIC is maintaining its position. The same applies to its active weighting of industrial metals, which are predicted to benefit from the easing of the trade disputes.
Overweighting of pound sterling in view of the diminishing probability of a hard Brexit
The latest news from Westminster suggests that a no-deal Brexit will be avoided. Jeremy Corbyn, leader of the opposition, has raised the prospect of a second Brexit referendum. Prime Minister May, however, is seeking to extend the negotiating period, to which the EU will probably agree. More certainty about Brexit means that many investors may sooner or later reduce their substantial underweighting of UK assets.
Convertible bonds still buoyant
Prices for global convertible bonds have risen significantly over the past four weeks, continuing the trend seen at the start of the year. Average equity sensitivity rose to 48 per cent due to the continued easing of the situation in the global equity and credit markets. US paper increased the most, climbing by 5 per cent once again. The other regions also benefited from the positive market conditions. The primary market took its time to get going again. An issue from the US company Fortive, with a volume of US$ 1.4 billion, was the biggest of the year so far. The market as a whole continues to be attractively priced overall.
Extraordinary meeting of the Union Investment Committee
The Union Investment Committee (UIC) made allocation adjustments at its extraordinary meeting on 12 March 2019. The committee views the latest agreement reached between the European Commission under Jean-Claude Juncker and the UK government led by Theresa May as a signal of the decreasing probability that marginal risks, such as a hard Brexit, will materialise. The UIC is therefore neutralising its yen position against the US dollar, which had been entered into for hedging purposes. It is also doubling the existing long position in pound sterling against the euro. These two steps will make the model portfolio slightly more bullish in terms of currencies.
However, the UIC is neutralising its current overweight positions in commodities. It is reducing industrial metals and energy commodities by 1 percentage point each. Conversely, the absolute-return weighting is being raised by 2 percentage points, which means that this part of the portfolio is back at the baseline allocation. The reason for neutralising the commodity positions is that they have performed well in recent weeks, and the price targets of Union Investment's commodity experts have largely been reached. From the UIC's perspective, the investment hypothesis has therefore paid off and profits are being taken.
No adjustments have been made to the other areas of the model portfolio, such as equities and fixed income. The risk positioning has therefore been confirmed at level 3 (RoRo meter).
Our portfolio holdings
Unless otherwise noted, all Information and illustrations are as at 26 February 2019.