Union Investment reaffirms neutral risk position
UIC neutralises equity ratio following price rally
UIC portfolio: neutral risk position maintained, but with a slightly more defensive focus
Market environment: globally, we have not yet reached the peak of the coronavirus pandemic; central bank measures are providing support
- Asset classes: weighting of equities from industrialised countries reduced slightly; government bonds from eurozone periphery countries slightly overweighted
RoRo meter at level 3, Risk positioning remains neutral
The Union Investment Committee (UIC) has confirmed its neutral risk positioning (RoRo meter at 3) but has shifted to a slightly more defensive stance. The committee believes that the support measures adopted by governments and central banks and the gradual easing of the containment measures have been widely priced in now. A further continuation of the upward trend would need to be driven by improvements in the fundamental market environment. This means that risk assets will remain attractive over a longer horizon. But in the short term, opportunities and risks are balanced relatively evenly in the wake of a strong rally and currently quite ambitious valuations.
The committee has therefore decided to collect profits on the overweight position in equities from industrialised countries and to lower the equity ratio to a neutral level. Spread products remain well supported by the actions of the European Central Bank (ECB). In addition to an active position in (investment-grade) corporate bonds, a position in government bonds from eurozone periphery countries will also be established. The closer political collaboration at European level should benefit these bonds and also the euro (long position against the US dollar). In light of low yields in the bond market, the committee regards absolute-return strategies as more attractive than covered bonds.
The epicentre of the pandemic has shifted to the emerging markets
Global economic activity has started to pick up slightly amid the gradual easing of lockdowns but still remains well below pre-crisis levels. The capital markets are still ignoring the weakness of the global economy and also the rising numbers of new infections in many places over the past few days. Instead, investors are focusing on news indicating that the economic impact of the coronavirus pandemic will be overcome in the medium term.
However, from a global perspective, the pandemic has not actually reached its peak yet. The epicentre has shifted mainly to Latin America and also a few other major emerging markets (Russia, India). In the industrialised countries, the risk of a second wave of coronavirus infections is rising in light of new localised outbreaks. The US, in particular, has seen the number of daily new infections at national level rising significantly more rapidly than can be explained solely by an expansion of testing. This is putting a damper on economic activity in the US as authorities are imposing new restrictions and consumers and companies are adapting their behaviour (e.g. renewed closure of Apple stores).
Government measures are supporting the US economy
Data from the US Employment Situation Summary for May was surprising in some respects. But according to our economists, the unexpected rise in jobs is largely attributable to a one-off effect caused by the launch of the government's paycheck protection program (PPP). The rise in US retail sales in May (up by 17.7 per cent compared with the previous month) should also be interpreted with caution. Despite the high level of unemployment, many US households are finding themselves with more cash than before the crisis. This is mainly due to one-off effects such as special payments from the government or temporary suspensions of debt repayment.
The support measures introduced by governments and central banks cannot prevent a severe recession but should mitigate negative second-round effects. It will take until mid-2021 for a sustained recovery to set in, which should see US economic growth recover to 3.6 per cent for 2021 as a whole (previous forecast: 2.8 per cent growth). Pre-crisis levels of economic output will probably not be reached before 2022 according to our economists. The world's major central banks have reaffirmed their expansionary monetary policy approach in recent weeks and some have expanded their quantitative easing measures even further. The Federal Reserve (Fed) is going to continue to purchase US Treasuries and mortgage-backed securities at least at the current monthly volume and, in addition, will now also make direct purchases of corporate bonds. Interest rates will most likely not be raised before the end of 2022. The ECB increased its pandemic emergency purchase programme (PEPP) by €600 billion in June to a total volume of €1.35 trillion and extended the period for bond purchases until at least the end of June 2021. Eurozone banks used the new targeted longer-term refinancing operations (TLTROs) in mid-June to obtain more than €1.3 billion of liquidity from the ECB.
Chart of the month: US labour market and income data uplifted in part by one-off effects
Equity weighting within the asset classes
Government bonds from eurozone periphery countries overweighted
The central banks' purchase programmes are continuing to provide strong support for the bond markets, with government bonds from eurozone periphery countries and corporate bonds particularly benefiting. A European recovery fund is likely to be established in one form or another, which will probably also cause yields to fall in periphery markets. Default rates are expected to remain in check in the investment-grade segment, even if a second wave of coronavirus emerges. Low yields combined with sluggish issuance activity make the covered bond market relatively unattractive.
Weighting of equities from industrialised countries neutralised
The global equity markets have continued to recover and valuations have reached an ambitious level. There is a risk of a second wave of infections going forward. Moreover, the tailwind provided by systematic investors is diminishing. Profit levels have recently stabilised and are likely to recover only slowly. In this climate, the UIC has decided to realise profits on equities from industrialised countries. Strategically speaking, however, equities remain a preferred asset class.
Commodities position held at neutral
Thanks to the extension – and strict implementation – of the restrictions on OPEC+ countries' output and the rapid curtailing of production by shale oil companies in the US, the global supply of oil has been brought down to the level of global demand. The oil market will therefore start the second half of the year in a state of equilibrium, albeit with significant excess volume in storage. Sustained demand from ETFs and low real rates of return are shoring up the price of Gold.
Political rapprochement is strengthening the euro
The discourse about a European recovery fund is continuing to provide a tailwind for the euro. The EU summit taking place this weekend may see further steps towards closer integration being taken. In the Brexit negotiations, the two sides are moving closer together, which is also sending a positive signal. The US dollar is likely to be adversely affected by outflows of capital from the US, as interest-rate cuts implemented by the Fed are prompting investors to look for more profitable investments elsewhere. Developments in the US election campaign are also expected to increasingly buffet the greenback.
Convertible bonds on an uptrend
Over the past few weeks, the convertible bond markets have climbed sharply thanks to the strength of the equity markets. US convertibles have made the most significant price gains and their valuations have also jumped. By contrast, valuations in Europe and Asia (excluding Japan) have fallen and the bonds are still cheap overall. The convertible bond market is exhibiting a high degree of convexity, with equity market sensitivity of around 57 per cent. Issuance activity has remained very brisk in recent weeks, especially in the US.
Unless otherwise noted, all information and illustrations are as at 23 June 2020.