UIC confirms its neutral risk positioning
Tactical underweight position in equities
- Stubbornly high inflation has now peaked
- Reporting season: smaller fall in profits than expected but outlooks still shrouded in uncertainty
- Strategic portfolio has a tactical underweight position in equities and an overweight position in commodities
- Spread segment preferred over safe havens
Outcome and justification
The Union Investment Committee (UIC) reaffirmed its neutral risk positioning (RoRo meter at level 3) at its meeting on 21 February. It did not make any changes to the strategic portfolio during the regular meeting either. However, the committee had previously adjusted its equity positioning. Following bouts of market turbulence in the first few weeks of 2023, the UIC neutralised the existing underweight position in equities at the start of the month but then reopened it for tactical reasons in mid-February. As a result, equities are currently underweighted (due to a reduction in holdings of stocks from industrialised countries). In return, the committee has opened an overweight position in commodities (by increasing holdings of industrial and precious metals), again for tactical reasons. It also halved the underweighting of government bonds from core eurozone countries, which means that fixed-income investments in the strategic portfolio now have a neutral weighting overall. The focus in this asset class continues be on spread products. In the currency asset class, the UIC still believes that the Japanese yen will appreciate and, in fact, expanded this position against the US dollar over the course of the month.
The biggest influence on the current positioning of the strategic portfolio is therefore the divergence of the equity markets from the fixed-income and commodity markets. Whereas bond yields have risen and commodity prices have fallen recently, equities appear oblivious to the tightening of funding conditions. Stubbornly high inflation rates and the related hawkish statements made by central banks have caused bond and commodity prices to drop, but not share prices. In the case of equities, these factors seem to have been outweighed by robust economic data, additional purchases by systematic investors and the closure of short positions. As a result, equities have now been on quite a run. The UIC views their current pricing as ambitious and believes a short-term setback is likely. The positioning in equities, fixed-income paper and commodities therefore reflects the UIC’s interpretation of this market expectation from a multi-asset perspective. At the same time, the anniversary of Russia’s invasion of Ukraine is likely to have raised the level of geopolitical risk, at least temporarily, and this is another argument against adopting a bullish stance.
If, however, the analysis period is extended slightly further into the future, the latest developments can be viewed positively overall. The global economy is performing better than expected, an energy crisis has not materialised and inflation has peaked. There is still some lingering uncertainty about the key factors that will affect the capital markets in 2023, as can be seen from the cautious tone of the outlooks published by companies in the current reporting season. However, the trends are pointing in the right direction. The time is therefore still expected to come for risk assets.
Economy, growth, inflation
In the western hemisphere, the economic data has stabilised on both sides of the Atlantic. Union Investment’s own leading indicator is showing an improvement – particularly for the US – and currently signalling upward momentum for the US economy. This is supported not only by the property market data represented by the NAHB index but also by good news on the consumer front (strong retail sales and a robust job market). The outlook is not entirely free of risk, as can be seen from a number of surveys in the corporate sector. The survey conducted by the regional Federal Reserve Bank in Philadelphia, for example, reflected the heightened level of uncertainty among companies. Overall, however, the prospects for US growth have brightened. Union Investment’s economists have therefore raised their 2023 forecast for gross domestic product (GDP) from 0.3 per cent to 1.0 per cent. They continue to anticipate a phase of economic weakness, although it will trigger only a brief foray into negative territory.
Inflation may remain stubbornly high for a time in this environment but it has now peaked. This was underscored by the data for January. The US consumer price index (CPI) rose by 6.4 per cent compared with January 2022, whereas the year-on-year change in December 2022 had been slightly higher at 6.5 per cent. This was the seventh fall in succession. The core rate – i.e. excluding energy and food prices, which are particularly susceptible to volatility – also showed signs of easing. By contrast, producer prices rose more than expected, with a year-on-year increase of 6.0 per cent, illustrating that the US economy continues to be subject to inflationary pressures. Union Investment’s economists predict that inflation drivers will lose their strength over the course of the year, believing that inflation is now on a sustained downward trend. They forecast annual rates of 3 per cent and just under 4 per cent for overall inflation and core inflation respectively by mid-2023. The average increase in consumer prices for 2023 is therefore likely to be around 4 per cent.
The economists continue to expect economic output to decrease in the eurozone during the winter months, albeit to a lesser extent than originally anticipated here too. There are various reasons for this. Energy shortages did not materialise, the supply situation continues to improve and China’s abandonment of its zero-COVID strategy is buoying foreign trade. The research team predicts a very modest upswing in 2023, with GDP growth of 0.2 per cent for the year as a whole, and does not anticipate a return to the trend growth rate until the end of 2024.
Monetary policy: continued pressure to act
The central banks are still under pressure, with surprisingly robust growth and stubbornly high inflation so far. This explains why the US Federal Reserve (Fed) and the European Central Bank (ECB) tried to convey a hawkish tone at their meetings in February. They did not really succeed, however. Many market players appear not to believe that the central banks will continue to ratchet up interest rates, despite the ECB more or less committing to raising interest rates by a further 50 basis points in March and the Fed stating that “ongoing rate increases” are to be expected.
After the Fed’s meeting, the UIC factored a further interest-rate hike in March into its forecast and now expects a terminal rate at the end of the cycle of interest-rate rises of 4.75 to 5 per cent. The hike in March is probably not necessary in terms of the fundamentals, but the Fed seems to have firmly resolved to go ahead with it. The UIC continues to anticipate that the ECB will raise its key rates by 50 basis points in March and a further 25 basis points in May. The committee’s forecast of a terminal rate of 3.25 per cent (for the economically important deposit rate) is therefore unchanged. It also believes that interest-rate cuts are not on the cards for 2023, neither in the eurozone nor in the US.
Divergence of the markets since mid-January
Equities supported by improved economic outlook; fixed income weighed down by a higher peak interest rate
Equities supported by improved economic outlook; fixed income weighed down by a higher peak interest rate
Fixed income: interest-rate cuts by the Fed priced out for 2023
In the bond markets, yields on safe-haven government bonds have risen again across all maturities in recent weeks. Persistently high inflationary pressure in the eurozone drove yields on two-year bunds up to a new high of 2.9 per cent. By contrast, yields on longer-dated Bunds and US Treasuries have not yet returned to their highs of recent months. Union Investment’s experts do not expect yields to climb much further in the coming months. In the US, the interest-rate cuts that market participants had anticipated for the end of the year were priced out again following a number of recent statements by members of the Federal Reserve (Fed). The UIC is maintaining its underweight exposure to government bonds from the eurozone and the US, focusing instead on investment-grade corporate bonds and hard-currency bonds from emerging markets. Yield premiums in both of these segments have already fallen considerably, but have probably not quite bottomed out yet. Activity in the primary market recently calmed down a little following a flurry of new issues at the start of the year. However, there are still new issue premiums available to be earned. The recent improvement in macroeconomic conditions prompted market participants to lower their expectations regarding probabilities of default. This helped the high-yield segment to outperform other assets by a sizeable margin. Nonetheless, the UIC is of the opinion that the segment is not valued very attractively in relative terms and is therefore maintaining a neutral stance.
Equities: scope for a correction following price gains
After an upbeat start to the year, the equity markets remained on an upward trajectory. However, the pace of share price gains has recently slowed down noticeably. The tailwind for equities came from better-than-expected macroeconomic data and corporate results and from hopes that the US Federal Reserve might start to lower interest rates again in the second half of the year. In addition, many investors had started the new year with relatively small equity exposures while many hedge funds had been heavily positioned on the short side. Rising share prices subsequently incentivised these market participants to bulk up their holdings and close out or reduce short positions. Corporate share buybacks have also been on the up. As a result, the equity markets have become decoupled from fixed-income and commodity market trends in recent weeks. The UIC expects this divergence to lessen again in the coming weeks. The committee considers the upside potential, particularly in industrialised countries, to be more or less exhausted for the moment. It has therefore made tactical adjustments to reduce its positioning in equities. The situation in China continues to be an important factor for shares from the emerging markets. Although the easing of Beijing’s zero-COVID policy has now been priced in to a large extent, it continues to support share prices, not least because the Chinese New Year holidays have not resulted in the dramatic spike of infections that many had feared.
Commodities: metal prices expected to recover
Commodity prices have continued to fall sharply in recent weeks, even though economic data has, for the most part, exceeded expectations. Saudi Arabia raised its list prices for oil exports to Asia, a move that has historically often had a signalling effect for prices in the wider commodity markets. But neither this nor strikes in the Peruvian mining sector did much to halt the nosedive. In the precious metals segment, record volumes of central bank purchases shored up the gold price, while the quasi-industrial precious metals palladium and silver and most industrial metals came under substantial pressure. Union Investment’s experts anticipate a recovery in the coming weeks. This will be driven by demand in connection with the end of the zero-COVID policy in China in the short term and, over the long term, by greater demand for metals as part of the transition to a green economy. The situation in the North Atlantic energy market has been improving lately. This was reflected, for example, in the fact that the price of diesel at the fuel pump dropped below the price of petrol for the first time in months. Imports from Asia and North America played a significant role in easing pressures in this market. Moreover, gas prices in North America and Europe also continue to fall, mainly due to the relatively warm weather. In the last twenty years, US gas prices have been lower only in 2012, 2016 and 2020. For the moment, the UIC is maintaining a neutral exposure to the energy sector.
Currencies: yen still favoured
Things are changing in Japan. Over the past thirty years, inflation rates in the country rarely climbed above 2 per cent, and if they did, they remained there only very briefly. However, recently, they have risen to as much as 4 per cent. This fuelled speculation that the Bank of Japan (BoJ) might soon call time on its ultra-expansionary monetary policy with negative interest rates and yield curve control (YCC). In addition, the top job at the BoJ will change hands in April. The Japanese government has nominated Kazuo Ueda as the successor for Haruhiko Kuroda, whose name has become inseparably linked with the bank’s ultra-loose approach. This personnel change will shift the tone of the debate about a monetary policy adjustment from “if” to “when”, which should support the Japanese yen. Following a period of weakness that set in at the start of the fourth quarter of 2022, the US dollar has stabilised again in recent weeks thanks to the macroeconomic environment and hawkish signals from the Fed. Although the interest-rate cuts that market participants had previously anticipated for the second half of 2023 have now been priced out, the greenback will continue to face monetary policy headwinds. This is due to the fact that the Fed is likely to reach the end of its cycle of interest rates sooner than the European Central Bank or the Bank of England, while Japan has not even started to raise rates. Consequently, the UIC is maintaining its long position in Japanese yen against the US dollar and the euro.
Convertibles: conditions remain positive
The generally positive sentiment in the equity markets is keeping convertibles on an upward trajectory. From a global perspective, US convertibles – especially paper from the tech sector – performed best. The average equity market sensitivity continued to rise, reaching around 57 per cent. Valuations also kept climbing. One of the reasons why some valuations have reached fairly high levels is that issuance activity has been muted in recent months while demand has been robust. However, in the last few weeks, activity in the primary market has picked up strongly across all regions.
Unless otherwise noted, all information and illustrations are as at 21 February 2023.