Union Investment confirms neutral risk positioning
Equity weighting raised slightly
Union Investment confirms neutral risk positioning
The Union Investment Committee (UIC) confirmed its neutral risk positioning (RoRo meter at 3) at its regular meeting in October. At the same time, it slightly raised the equity weighting by neutralising the previous underweighting in the emerging markets segment. This, in combination with the existing overweight position in the industrialised countries, means that our model portfolio is now overweight in equities. By contrast, the weighting of government bonds from the core eurozone countries was reduced again. The heavy emphasis on the carry segments of the bond market has been explicitly confirmed. No adjustments were made to the other sectors.
The UIC’s decision is based on the fall in risk premiums in recent weeks as a result of progress being made in the trade dispute and Brexit. The economic situation is showing small signs of improvement, but as yet there is no broad-based recovery. Although monetary policy is continuing to provide support, the UIC believes that the impact of central banks’ actions will begin to wane. The overall picture as things stand bears out a model portfolio with a moderate yet constructive positioning.
Economy is stabilising
The short-term economic trend is beginning to stabilise. UI’s proprietary leading indicators for the US and the eurozone have improved of late, as have the purchasing managers’ indices for a number of regions. In regional terms, positive signals have also been emerging from the eurozone (e.g. from France). The Italian and Germany economies, which had been faltering, have not deteriorated any further.
Recent data from the world’s biggest economies, the US and China, has been mixed, however. So it’s still too early to talk about an economic turnaround at global level.
The recent rapprochement in the trade dispute has also failed to significantly improve the underlying situation and this means that global trade is continuing to suffer. The UIC is therefore maintaining its moderate economic outlook for the coming months.
Monetary policy: the Fed has delivered
On 30 October, as expected by Union Investment and the markets, the Federal Reserve (Fed) cut its key interest rate range by 25 basis points and kept all its options open for the months ahead. The actions of the Fed should continue to be guided by the data going forward, which means that the hurdles for a further rate cut have been raised. The UIC therefore considers a further interest-rate cut in December to be unlikely, although the Fed could easily be forced into a making a U-turn if the macro data is unexpectedly poor. Based on our expectation of weak economic growth in the US, the country is likely to see two further rate cuts in 2020. The European Central Bank (ECB) is launching its new asset purchase programme on 1 November. Union Investment expects that the ECB will focus on corporate bonds in order to avoid legal action being brought, as some believe the programme constitutes illegal state funding.
Charts of the month: German export expectations are improving; upward pressure on safe havens
Asset classes: Equity weighting raised slightly
Fixed income slightly underweighted overall: The generally waning level of risk aversion is likely to lead to modest yet sustained upward pressure on the yields of government bonds from the core eurozone markets and covered bonds. The spread segments, meanwhile, should continue to benefit from investors in search of returns and, for investment-grade corporate bonds and periphery bonds in particular, the launch of the ECB’s bond-buying programme. A Fed in expansionary mode and a weaker US dollar are likely to bolster government bonds from the emerging markets. The UIC is maintaining its cautious approach with regard to high-yield corporate bonds because of the weak economic situation.
Emerging market equities upgraded to neutral: Profit growth and global growth are the main factors driving the equity markets. Corporate profits are still largely solid, as the Q3 reporting season is showing. There have also been recent signs of rapprochement in the US-China trade dispute. This easing of tensions is having a particularly positive impact on China, which is heavily integrated into global trade. The Fed’s recent rate cut suggests that the US dollar will weaken, which will provide a further fillip to the emerging markets.
No change in strategy for commodities: The slump in oil output following the drone attack in Saudi Arabia could reverse more quickly than originally expected. However, there is still likely to be a supply deficit – albeit a small one – in the fourth quarter of 2019. The energy market continues to offer an attractive roll yield, so the committee is maintaining its overweight position in energy commodities. Precious metals are underweighted, however. Gold, in particular, has been on quite a run following the fall in real interest-rates in recent months and is now expensive.
Falling risk premiums on currencies: The US dollar’s upward momentum looks set to end for a combination of reasons: waning risk aversion, the much more significant loosening of US monetary policy in comparison with other regions, the Fed’s higher tolerance for inflation, and the potential for economic recovery to set in slightly earlier in the rest of the world. The expectation of the UK now making an orderly exit from the EU means that pound sterling is likely to appreciate while its risk premium falls.
Strong US convertible market: In October, the US convertible bond market matched the upward trend in the equity markets almost point for point. The European market was relatively weak and Asia, including Japan, saw a modest rise. Delta (sensitivity to changes in value of the underlying stock) stood at 47 per cent. Convertibles thus continue to offer a balanced profile with a high degree of convexity to the equity markets. The volume of new issues fell significantly in October due to the quarterly reporting season.
Our portfolio holdings
Unless otherwise noted, all information and illustrations are as at 31 October 2019.