Union Investment maintains its neutral risk positioning
Carry position expanded
Risk positioning confirmed at level 3 (RoRo meter)
At its regular meeting in July, the Union Investment Committee (UIC) retained its generally neutral stance, confirming the risk position at level 3 on the RoRo meter. The model portfolio still has a neutral structure, but its focus has shifted. Firstly, this is due to decisions made by the US Federal Reserve (Fed) and the European Central Bank (ECB). Secondly, the economic picture has not brightened at all and the trade dispute is taking centre stage again.
US President Donald Trump has just announced new 10 per cent tariffs on a further US$ 300 billion of Chinese imports with effect from 1 September. This suggests that there has been no rapprochement between the US and China in the trade dispute. The move comes as a surprise, and Beijing is likely to retaliate.
Economic environment remains weak
The economy is showing no signs of recovery. The external and our own leading indicators have still not emerged from their period of weakness and many of them once more fell short of expectations. Union Investment has again slightly downgraded its growth forecasts for the current year. We predict a 2.4 per cent rise in economic activity for the US, and 1.0 per cent for the eurozone. Germany is suffering as its export-driven economy has been hit particularly hard by the slowdown in global trade. We therefore anticipate that its gross domestic product will now grow by only 0.6 per cent.
In other words, Union Investment continues to view the prospects for global growth as poor. However, we are not expecting a recession, provided the trade dispute does not escalate into a trade war. The monetary policy stimulus recently decided upon should inject some momentum into the economy going forward.
Monetary policy: back to expansionary mode
As anticipated, the Fed lowered its key interest rate by 25 basis points to a range of 2.0 to 2.25 per cent on 31 July. It also ended its balance sheet reduction process earlier than planned, implicitly introducing another expansionary measure. Contrary to what the markets were expecting, however, the Fed is in no hurry to make another move on interest rates and is unlikely to reach a decision on this before the end of the year at the earliest.
In line with expectations, the ECB did not change its interest rates in July but did announce an extensive package of expansionary measures for September. Firstly, a tiered system is to be developed that would enable a bigger reduction in interest rates with as little impact as possible on the banking sector. Secondly, the relaunch of the asset purchase programme is being prepared. In September, Union Investment expects the ECB to cut interest rates by 25 basis points, implement a tiered system and announce new asset purchases to the tune of €30 billion per month from the start of 2020. If the Fed’s interest-rate reduction causes the US dollar to weaken, we believe the ECB is likely to lower all three of its benchmark rates by a further 10 basis points in December.
Charts of the month: global trade diminishes; corporate bonds likely to benefit from ECB moves
Asset classes: industrialised countries’ equities reduced, stronger focus on spread products in the fixed-income asset class
Stronger focus on carry
The monetary policy measures mean that interest rates remain resolutely low and have actually fallen even further. The conditions for fixed-income investments are therefore still fundamentally positive. Yields on safe government bonds, such as German Bunds and US Treasuries, have dropped sharply in recent weeks and are expected to go down a little bit more. Spread segments are also likely to remain in demand, firstly because of the hunt for returns and secondly because of the ECB’s plans to relaunch the asset purchase programme. Nonetheless, it is important in the current economic climate to pay more attention to individual security selection. One of the factors bolstering government bonds from emerging markets (EMs) is the low real rate of return. The UIC is therefore maintaining its overweighting of hard-currency EM bonds. And it is further expanding its overweight position in investment-grade corporate bonds in view of the additional support provided by the ECB. Conversely, the UIC is again reducing its exposure to covered bonds because their yields and spreads are currently low.
Underweighting of paper from industrialised countries
Trump’s announcement of new tariffs focuses attention on the trade dispute once again. The tariffs, which will be introduced in September, also affect consumer products. The impact will therefore be greater. Profit expectations are likely to be hit to a greater extent. With the US election campaign about to get under way, the UIC anticipates that the trade dispute will remain in the spotlight and create further uncertainty in the markets. In this climate, the committee has decided to adopt a more cautious stance in respect of equities from industrialised countries. The trade dispute is also having a knock-on effect on EM equities, although they continue to receive support as a result of the renminbi’s sharp depreciation. Consequently, the UIC is retaining its neutral positioning in EM equities.
Neutral weighting for commodities maintained
There is likely to be an oversupply in the oil market next year, putting downward pressure on prices. Industrial metal inventories are stabilising at a low level; a surplus of lead and zinc is expected from 2020 onwards. Market players are still hoping for stimulus from Chinese infrastructure measures. The price of gold has benefited from falling US real interest rates in recent weeks. Investors have increased their positions on a huge scale, but the UIC believes most of the potential has now been exhausted. The committee is maintaining its neutral weighting for commodities.
Long US dollar vs. EM currencies
The Fed’s failure to deliver what the markets were expecting has pushed up the US dollar’s value significantly. The UIC anticipates that the US central bank will dampen hopes of further interest-rate cuts. The US dollar is therefore likely to maintain its strength. Conversely, the poor economic conditions and the resurgence of the trade dispute are weighing down on currencies from the emerging markets. Another reason why the US dollar will probably stay firm is that the ECB is expected to take a more expansionary approach than the Fed over the remainder of the year.
Sustained uptrend for convertible bonds
The positive performance of the stock markets has led to a further rise in the convertible bond market over the past four weeks. Overall, it continues to exhibit a high degree of convexity, with equity sensitivity of just under 46 per cent. Seasonal factors have limited the number of new issues, most of which came from the US and were well received by the market.
Our portfolio holdings
Unless otherwise noted, all Information and illustrations are as at 2 August 2019.