Union Investment retains moderately bullish risk positioning
UIC confirms overweighting of equities
Moderately bullish risk positioning, RoRo meter still at 4
The Union Investment Committee (UIC) believes that the market environment remains positive with good conditions for the start of the new trading year in 2020. The committee has therefore confirmed the risk positioning (RoRo meter) at level 4. It has also retained the overweight position in equities, albeit with a broader base. Specifically, the UIC has overweighted equities from the emerging markets and, in return, reduced the long position in developed markets. The committee is also eliminating the underweighting of high-yield bonds by paring back the position in investment-grade bonds. In the commodities asset class, an overweight position in industrial metals has been opened.
The main reason for this is the degree of calm that has now emerged around the trade dispute and Brexit. The ‘phase-one’ deal between the US and China points to an easing of tensions, although the importance of the agreement should not be overrated. And while there are still uncertainties about future trade relations after Brexit, Johnson’s election victory does mean the marginal risk of the UK crashing out without a deal is off the table. In the UIC’s view, this reduction in marginal risks outweighs both the fairly weak economic data and the initial early warnings regarding sentiment and positioning.
Economic conditions are still poor
Hopes of an economic upturn have not materialised. As before, the industrial sector in particular is very weak. The latest purchasing managers’ indices for manufacturing fell, both for the US and for Europe. The European indicator’s slide in December, from 46.9 points to 45.9 points, was especially concerning. Nevertheless, the stable indices for the service sector show that, so far, the weakness has been confined to industry and will dissipate again as the year progresses. The UIC believes this situation will remain unchanged in 2020, which will result in an overall slowdown in growth. However, none of the major economic regions are expected to slip into recession.
The initial ‘phase-one’ deal reached is likely to eliminate some of the uncertainty going forward and support an upturn over the course of the year. However, the agreement should not be seen as fundamentally resolving the trade dispute and thus eliminating the problems in the real economy. To put it into context: The tariffs that the US President has now withdrawn equate to around 8 per cent of the total volume issued since 2017.
Charts of the month: Most tariffs remain in place after the "phase-one" deal
Monetary policy: Lagarde picks up the baton
There have been no significant changes to monetary policy of late. Neither the US Federal Reserve (Fed) nor the European Central Bank (ECB) – nor any of the other major institutions that set the tone – have altered their direction in December. There have been some notable events this month, however. Christine Lagarde chaired her first monetary policy meeting as President of the ECB. A shift in the fundamental direction is not expected, as her predecessor Mario Draghi has set a course for well into next year. Moreover, monetary policy now has less of an impact on the economy following years of ultra-expansionary measures. Lagarde will make her mark nonetheless. Firstly, she is placing greater emphasis on seeking consensus both within and outside the ECB. Secondly, she is shining the spotlight on different subjects, such as climate change and social inequality, and this is likely to be reflected when the ECB’s 2020 strategy is updated.
In the US, the Fed reiterated that further monetary policy moves would depend on the performance of the economy. Given this situation, the UIC continues to believe that the Fed will probably respond with another two interest-rate cuts if growth continues to diminish. The more resilient the US economy proves to be, the more unlikely such measures would become.
Equity weighting within the asset classes
Broader base of corporate bonds
The hunt for returns and the ECB’s purchase programme are resulting in narrowing spreads across the board in all spread segments. US companies have realised that they can take on debt more cheaply in the eurozone than in their home market as a result of the strong demand and low interest rates in Europe. Consequently, they have been issuing euro-denominated bonds in record volumes. Against this backdrop, we have taken a less pronounced position in corporate bonds than previously. Demand for both segments is likely to remain high in January. The traditional safe havens are holding steady despite decreasing levels of risk aversion, but in absolute terms they are not attractive.
Overweight positioning distributed between shares from industrialised nations and emerging markets
The core drivers of the equity markets are corporate profits and global growth. As far as corporate profits are concerned, the picture is still predominantly solid and expectations for the fourth quarter are likely to be met. Levels of profit growth in the emerging markets and in industrialised nations have stabilised relative to one another in recent weeks. The political and geopolitical uncertainties resulting from the trade dispute and from Brexit have diminished significantly as a result of the ‘phase-one’ deal and the emphatic election victory of Johnson’s Conservative Party. Although investor sentiment was already positive, and despite higher prices, a continuation of the upswing is likely.
Industrial metals slightly overweighted
OPEC surprised the markets with its production cuts. Although the market surplus for the first half of 2020 will now be reduced, seasonal demand for energy commodities remains weak. High inventory levels for some distillate products are another reason not to increase exposures. Industrial metals, on the other hand, have much better prospects. By historical standards, inventories are at a very low level, due in part to the closure of production facilities in China. Even slight impetus from China is likely to bolster prices. The UIC believes there is an asymmetric risk/reward profile in this segment.
No change of positioning in currencies
Under Boris Johnson’s negotiating plans, the period of Brexit uncertainty for companies would be reduced. On the other hand, this very challenging timeline could be an indication of tough negotiations with the EU. The UIC is therefore remaining on the sidelines as far as the pound is concerned. The same applies to the euro/US dollar currency pair. The benign market environment tends to favour a strong euro. Conversely, the growth in euro-denominated bonds being issued by a number of US companies is creating constant demand for the greenback as a result of the associated currency hedging.
Volatile month for convertible bonds
The correction in the equity markets at the beginning of December also resulted in increased volatility for convertibles worldwide. However, all regions apart from Europe were able to recover quickly and consequently equity sensitivity rose to around 50 per cent. The price of global convertibles rose slightly but they remain fairly priced. There have been fewer new issues in the past four weeks than in previous final quarters.
Our portfolio holdings
Unless otherwise noted, all information and illustrations are as at 17 December 2019.