Union Investment Committee raises equity weighting
UIC portfolio: neutral risk positioning reaffirmed
RoRo meter still at 3, Risk positioning remains neutral
The Union Investment Committee (UIC) has reaffirmed its neutral risk positioning (RoRo meter at level 3). At the same time, it has made the model portfolio slightly more bullish by increasing the weighting of equities and reducing the weighting of all commodity segments (except precious metals).
The reason for this decision is the committee’s constructive view of the prospects for risk assets. The global economy is continuing to stage a moderate recovery, and monetary policy is still providing strong support. As a result, the low or negative real interest rates offered by ‘safe havens’ are prompting investors to increasingly opt for alternatives. Investments with higher returns – such as the spread segments in the fixed-income asset class and equities – are benefiting from this shift, as are precious metals such as gold. When it comes to allocation decisions, therefore, historical pricing levels are becoming less important and need to be evaluated in the context of the generally lower level of interest rates.
Compared with other asset classes, commodities are much more dependent on economic conditions, which are continuing to improve, not least because more economic normality is promised by encouraging news about the development of vaccines and coronavirus tests. However, many commodity segments have already priced in this situation to a significant extent.
Economy, growth, inflation
The economic collapse triggered by the coronavirus pandemic was unprecedented. There have been clear signs of an initial rebound since the low point reached in April. The result has been rapid economic growth for the US, Europe and, in particular, China in the third quarter of 2020. This trend is set to continue but lose momentum during the autumn. Firstly, there is likely to be no sustained let-up in the pandemic at least until the end of 2020. Social distancing measures will therefore remain the norm, resulting in reduced value creation. Secondly, economic activity is being held back by persistent economic effects. All in all, the UIC continues to anticipate that the upturn will take the shape of a tilted V, i.e. a moderate recovery of growth.
The prospects for inflation are currently the subject of fierce debate among economists. At the moment, the UIC does not see any indications of increasing upward pressure on prices; if anything, it is the contrary. Although the coronavirus crisis has had a significant impact on prices, the general picture of sustained low inflation will not change for now. This is because the price-dampening effects of high unemployment and the general uncertainty acting as a brake on consumer spending and capital expenditure have the upper hand. For 2020 as a whole, we predict inflation of 0.7 per cent for Germany and 0.5 per cent for the eurozone. Inflation is likely to be slightly higher in the US at 1.0 per cent.
Monetary policy: Fed’s shift heralds evolution
The focus of central banks worldwide is on tackling the crisis and stimulating growth, not on containing inflation. This can clearly be seen from the US Federal Reserve’s strategy shift announced by its chair, Jerome Powell. In future, the Fed will be targeting inflation that averages 2 per cent over time; in other words, its target will have a ‘memory’. This means that sustained phases of low inflation will make subsequent phases of higher inflation more acceptable. The US central bank also emphasised that maximum employment was a broad-based and inclusive goal, marking an evolution in its monetary policy. Although this creates more uncertainty about inflation going forward, the policy shift makes the direction of monetary policy even clearer: The Fed will remain on an ultra-expansionary course for a long time to come.
Chart of the month: Milestone – Hopes raised by coronavirus tests
Equity weighting within the asset classes
Fixed-income spread products are the beneficiaries
The central banks’ asset purchase programmes are continuing to support the bond markets. Companies have been quick to make use of this favourable environment and have already issued new paper to cover most of their funding needs for 2020. This autumn could see an increase in primary market activity as companies seek to capitalise on these conditions to bring forward some of their funding activities from 2021. In the emerging markets segment, the phase of significantly narrowing spreads is now over. The high current yields remain attractive, but the way coronavirus cases are rising in many developing countries is giving cause for concern. Yields on safe-haven bonds are likely to trend upwards and yield curves look set to steepen.
Increased numbers of infections fail to make an impression on equity markets
Global equity markets are continuing to rise, driven by the ‘hunt for spreads’ and structural growth themes such as digitalisation. The already ambitious pricing has moved up another notch. Although corporate reports for the second quarter of 2020 were better than had been feared, only the US mega-corporations and a handful of other companies were able to report increased profits. Other sections of the equity market, by contrast, are reflecting the weak state of the economy. Careful selection therefore remains the order of the day for successful investment in equities. In addition, encouraging news about the development of coronavirus vaccines and new types of test are increasingly helping to allay fears in the capital markets of a second wave of the pandemic.
Commodities offer limited potential
The situation in the commodities markets is, for the most part, returning to normal and the supply situation is stable. The surpluses in the energy sector are correcting themselves and inventories are consequently starting to fall again. China has massively expanded steel production as part of a classic economic stimulus programme and now has a share of the global market in excess of 60 per cent as steel production in the rest of the world has slumped by more than 20 per cent. However, the latest indicators suggest that the level of economic stimulus is waning. We also anticipate that Chinese demand for copper will decline. Following the market correction of recent weeks, we believe that the price of gold is once again broadly in line with the level of real interest rates in the US.
Euro still favoured
The euro has benefited significantly from the agreement on a European recovery fund and could be given another boost in the event of further progress towards fiscal union and closer integration overall at European level. Over the coming weeks, the upcoming presidential election in the US will increasingly dominate what is happening in the currency markets. We expect the US dollar to remain weak in the medium term due to the continuing rise in the US twin deficit, the flatter US yield curve and the Fed’s stated willingness to tolerate a higher level of inflation. The increasing likelihood of a hard Brexit against a backdrop of faltering negotiations between the UK and the EU is likely to put downward pressure on pound sterling.
Robust performance from convertible bonds
The strength of the equity markets in recent weeks has meant that convertible bonds have performed well. Equity market sensitivity is holding steady at around 54 per cent while valuations continue to rise. The implied volatility of convertible bonds fell again recently and has now returned to around its long-term average level. Recent weeks have seen another increase in the number of new issues, especially in the US, and they have been well received by the market.
Unless otherwise noted, all information and illustrations are as at 1 September 2020.