Union Investment Committee opts for carefully selected exposures
Market conditions offer opportunities but the challenges have increased
- Pace of growth returning to normal; debate about tapering is getting louder
Risk posed by the delta variant has only a limited impact on the market
UIC retains its neutral risk positioning (RoRo meter at level 3)
RoRo meter remains at level 3, risk positioning still neutral
At its regular meeting in August, the Union Investment Committee (UIC) reaffirmed its neutral risk positioning (RoRo meter at level 3). It did not make any changes to the model portfolio. In the middle of the month, the committee had already adopted a neutral position in equities and commodities, which had previously been overweighted. Consequently, the UIC’s overall stance is now more cautious than at the end of last month.
The reasons for this step were the slowing pace of growth and the spread of the delta variant of COVID-19. At the same time, the debate about scaling back bond purchases (tapering) by the US Federal Reserve (Fed) is getting louder. The UIC views these negative factors as only temporary. It does not expect strict coronavirus restrictions to be reimposed in western countries, for example. The experts see the slight easing of the pace of growth as a return to normal rather than a reversal of the economic uptrend. Moreover, corporate profits remain at a healthy level. Overall, the market conditions offer opportunities but the short-term challenges have increased. The second half of the year is likely to be dominated by careful asset selection and tactics.
Against this backdrop, the fixed-income segment continues to be underweighted in the model portfolio as a result of the positioning in safe-haven government bonds. The UIC anticipates rising yields on these bonds. Equities have a neutral weighting. To neutralise their previous overweighting, a ‘long developed markets versus short emerging markets’ pairs trade was entered into, which means that the UIC is expecting developed markets to perform well relative to emerging markets. This expectation is based on the growth forecasts, which have declined more noticeably of late, especially in Asia. Other factors at play include the tighter regulatory requirements introduced by Beijing and their adverse impact on Chinese equities. The absolute-return position was bulked up further because the UIC believes that it offers higher potential returns than safe-haven bonds or cash.
Economy, growth, inflation
The pace of growth has recently slowed in many regions of the world, as can be seen from Union Investment’s leading indicators ULI, ELI and CLI. In the US, a slight fall in retail sales, weaker property market data and a gloomier Philly Fed index make it clear that the economy is losing momentum. The latest leading indicators in Europe (such as the purchasing managers’ index, which has declined slightly) also point to a slowing of the recovery. But this is not thought to be a reversal of the economic uptrend. Rather, the data points indicate that the rate of expansion is flattening out, i.e. the situation is returning to normal as would be expected after a period of strong growth. This effect is particularly pronounced in China, which is again confronted with a rise in coronavirus cases after months of calm. Moreover, credit-led demand has weakened in China.
In terms of inflation, the picture from recent months has not changed of late. Inflation rates have been pushed up by low base effects, the impact of the reopening (including pandemic-related shortages) and, in the US at least, a boost to demand as a result of government support. Union Investment’s economists anticipate that these factors will be temporary for the most part. In the second half of 2021, inflation is expected to persist at elevated levels for a time before it settles down again as 2022 approaches. According to the economists, the definitive criterion for a sustained increase in the inflation rate would be the emergence of a distinct wage-price spiral. However, there are no signs of this at the moment, as can be seen from the level of the pay demands being made in the current collective bargaining rounds.
Monetary policy: Fed takes first steps towards tapering
At the most recent meeting of the Federal Open Market Committee, the Fed took a first, cautious step in the direction of tapering. According to Fed Chair Jerome Powell at the subsequent press conference, various tapering scenarios were discussed. This is a clear indication that plans are being made to start paring back bond purchases. The minutes of the Fed’s meeting, published two weeks later, further substantiated these intentions. Deliberations at the central bank summit in Jackson Hole will presumably shed even more light on the matter. In summary, the likelihood of the US central bank switching to tapering mode sooner than originally anticipated has increased of late. The UIC expects a reduction in monetary policy support sometime around the end of 2021 / beginning of 2022. The Fed’s first interest-rate hike would then probably follow in the first half of 2023.
The European Central Bank (ECB) will need to decide whether it wants to extend its PEPP beyond March 2022 in order to ensure that the economy is firmly on course for a return to its pre-pandemic trajectory and that inflation is therefore also coming back into line. It is the UIC’s view that the ECB will carry on purchasing bonds in considerable quantities even after a potential termination of the PEPP in March 2022 and that it will continue to support the eurozone economy for some time yet. The bank is keen to ensure that financing conditions do not deteriorate too much, too soon or for the wrong reasons. In July, the ECB reiterated that it was possible that inflation would temporarily rise moderately above the target level of 2 per cent. In this context, the bank would be taking into account that interest rates are currently more or less as low as they can be. Whether the ECB will actively promote a rise in inflation above 2 per cent or whether it will merely tolerate it if it happens, remains a point of contention among the members of the ECB’s Governing Council. Net asset purchases are consequently not expected to come to an end until the end of 2023, meaning that a first interest-rate hike is unlikely to happen before 2024.
Global economic growth starting to normalise
Union leading indicator (ULI)
Normalised 3-month change
China leading indicator (CLI)
Normalised 3-month change
Chinese credit-led demand
Year-on-year change in each case
12-month average shifted by 3 months
Equity weighting within the asset classes
Fixed income: rising yields expected on safe havens
Despite the recent decline in yields on safe-haven bonds, the factors likely to drive a continuing rise in yields over the coming months (healthy growth, elevated levels of inflation, tapering talk from the Fed) remain intact. The greatest threat to this scenario still lies in the spread of the delta variant of COVID-19 and any renewed imposition of lockdowns as a result. In this context, the yield forecast for ten-year Bunds at the end of the year has been lowered to minus 0.3 per cent. Safe-haven government bonds barely reacted to the recent weaker growth data, but the slowing pace of economic growth put downward pressure on the more opportunity-oriented segments of the fixed-income market, where spreads widened slightly. The UIC considers opportunities in these segments of the market to be limited in the coming weeks.
Equities: preference for stocks from the industrialised countries
Despite declining momentum as a result of the normalisation of growth trends, the increasing spread of the delta variant, the end of what has been a very good reporting season for the second quarter and growing talk of tapering, the upward trend for equities from industrialised countries has continued. Negative news has, at most, resulted in minor setbacks that were viewed by investors as opportunities to buy as equities generally remain well supported. That said, the headroom for further growth is becoming ever more limited. Conversely, the stock markets of the emerging economies have been buffeted at times by discussions around a tightening of regulation in China. New rumours and announcements hit the index heavyweights of the emerging markets in the Asian tech sector particularly hard. Following heavy price losses, there have been signs of a rally recently, but it is still too soon to give the all-clear. Nevertheless, this could well be an area in which tactical opportunities arise going forward.
Commodities: slowing growth already priced in
Following weaker economic data and recent increases in coronavirus infection rates, commodity prices have started to come under pressure. Highly cyclical commodities, such as industrial metals and energy, have been particularly hard hit, but precious metals have not been immune to the downward trend either. In the wake of these developments, the price of gold has become even more decoupled from real interest rates in the US, making the precious metal even more undervalued. In the view of the UIC, however, it is still too soon to move into the precious metal sector. The quasi-industrial precious metals platinum and palladium are particularly affected by the slowing economy and the sector could suffer as a result of the upcoming tightening of monetary policy by the Fed. The oil market is set to remain in a situation of excess demand for some time yet. However, OPEC+ members will meet on a monthly basis in future, allowing them to adjust production and reserve capacities to demand more frequently. Going forward, the supply and demand situation in the energy markets is likely to move progressively towards equilibrium.
Currencies: US dollar remains supported by taper talk
The debate surrounding a reduction of bond purchases by the Fed, which has been given fresh impetus by the recently published minutes of the July meeting, remains one of the central drivers for the US currency. As long as the US central bank is further ahead in these discussions than other central banks (such as the ECB), the US dollar will continue to have systemic support. Or to put it another way, currencies from countries and regions that are not so far along the road in this respect (such as the eurozone) are likely to be weaker. Risk sentiment is another factor driving the US dollar. Since the pace of growth started to slow, demand from investors for the US currency (and also for the Japanese yen) has been growing as they are considered to be safe havens. Under these circumstances, demand for more cyclically sensitive currencies (such as the euro) tends to diminish.
Convertibles: a weak month
In recent weeks, equity markets have come under significant pressure at times. China has been a particular drag on the global convertible bond market, while the largest regional market, the US, has also weakened. Average equity sensitivity fell to around 50 per cent. Valuations held steady and are now in a range between favourable and fair. Several issuers came back into the market recently, most notably in the US, and the new issues have been well received by the markets.
Unless otherwise noted, all information and illustrations are as at 24 August 2021.