Union Investment maintains its neutral risk positioning
Emphasis on defensive segments
Risk positioning confirmed at level 3 (RoRo meter)
At its regular meeting on 20 and 21 May, the Union Investment Committee (UIC) again adopted a slightly more defensive position. It thus continued on the risk reduction route that it had embarked upon during an extraordinary meeting at the start of the month. At the same time, however, the committee is maintaining its risk positioning at level 3 (RoRo meter), only adjusting the model portfolio here and there to reflect the changed, yet more uncertain, conditions.
The main sources of uncertainty are the developments at (geo)political level, above all the worsening of Chinese-US trade relations. Although Donald Trump has so far managed to avoid the final escalation of the trade dispute, the combination of US strategic opposition to China and the unpredictability of the US President poses a risk for the capital markets. From an economic perspective, everything indicates that Washington and Beijing will reach an agreement. So although further escalation is currently not anticipated, it cannot be ruled out entirely and would have a detrimental impact on the markets. Against this backdrop, the UIC believes that the G20 summit on 28 and 29 June will be pivotal. It will give US President Trump and China’s President Xi Jinping the opportunity to meet face to face and reach an agreement.
The latest developments surrounding Brexit and the imminent European elections are increasingly coming to the fore. The election may see populist candidates picking up votes. Although the latest polls indicate that the direct consequences for the capital markets are likely to be modest in the first instance, this tilting of the political axis in EU member states will create a challenge for the eurozone in the medium term.
Disparate economic conditions
The economy has recently been showing increasing signs of improved growth. This could be seen, for example, from our own leading indicators, ULI, ELI and CLI, which climbed sharply over the past few weeks. Some of the purchasing managers’ indices for the manufacturing industry also appeared to be turning the corner, especially in industrialised countries. However, growth surprises remained negative. This was particularly true in emerging markets.
The resurgence of the trade dispute has emerged as a further source of strain. It is difficult to gauge the direct economic impact in such a short space of time. In the long term, however, a reduction in trade and the brake on globalisation will restrict growth and push up inflation. Economically speaking, the consequences are thus definitely negative. The losers in the trade dispute are the (current) winners of globalisation, i.e. open economies in Asia and Europe.
Monetary policy – a reliable prop
In recent weeks, the consensus among the world’s major central banks has been that anxiety about rapidly rising inflation has given way to concerns about the resilience of the economy. The central banks are thus prepared to accept inflation targets being exceeded rather than run the risk of jeopardising growth by tightening the monetary policy reins too soon. For this reason, the UIC does not anticipate interest-rate hikes in either the US or the eurozone this year.
Charts of the month: Depreciation of the yuan in response to US tariffs; clear spikes in trade war tweets
Underweight position in equities and currencies from emerging markets
Carry remains in focus despite more risk-averse positioning:
Conditions for carry segments are likely to stay benign for as long as the main central banks remain cautious with their monetary policy. Nonetheless, the trade dispute is bound to have an impact, particularly on the riskier bonds. Over the coming weeks, it is therefore likely that investment-grade corporate bonds will benefit rather than those in the high-yield segment. As a precaution, the UIC is also largely eliminating its underweighting of safe havens – government bonds from core eurozone countries and covered bonds – because these would probably benefit immediately in the event of further escalation. By contrast, the overweight position in emerging market government bonds (hard currency) was confirmed. Unlike EM equities and currencies, this segment’s performance is more closely linked to that of US Treasuries. Moreover, when it comes to hard-currency bonds, Asia – and first and foremost China – does not play the same role that it does in the equities asset class.
Emerging market equities are underweighted:
The trade dispute is also driving decisions on the equities side. China is currently harder hit by the increased import tariffs and threats of further tariffs than the US, not least because the emerging markets are more closely integrated into global trade. In addition, the profit situation is currently more positive for equities from industrialised nations than for those from emerging markets and the latter are no longer favourably priced. For these reasons, the committee is now reducing the weighting of emerging market equities. Equities from developed markets remain neutrally weighted, meaning that equities overall are slightly underweighted.
Energy commodities remain overweighted:
US waivers for eight countries, exempting them from the ban on Iranian oil imports, expired on 2 May. Consequently, the supply of oil from Iran has contracted by around 500,000 barrels per day. At the same time, the OPEC+ nations have announced ahead of the major OPEC meeting at the end of June that they are in favour of maintaining the production cuts, while in Venezuela there have been disruptions to production. This reduced level of supply will come up against a seasonal rise in demand over the coming weeks (‘driving season’), which is likely to push up the price of oil. At the same time, the futures curve is pointing towards an extreme shortage in the oil market (Brent). We anticipate that the oil market will tip into supply-side deficit in the third quarter. The UIC has therefore decided to maintain the overweighting in energy commodities.
Long on US dollars and the euro versus emerging market currencies:
The escalation of the trade dispute is likely to continue to impact adversely, directly or indirectly, on Asian currencies. China could find itself in a situation where it is forced to devalue the renminbi once again, and this could have a knock-on effect on countries such as Korea and Taiwan via international supply chains. Consequently, the committee is reducing the weighting of emerging market currencies. In order to spread risk, offsetting positions are being taken in both US dollars and euros, even though most Asian currencies trade primarily against the dollar.
Convexity in the convertible bond market remains high:
The downturn in the equity markets has also resulted in a fall in the convertible bond market in recent weeks, particularly in the US and Asia. Volatility has increased markedly and valuation levels have risen both in Europe and Japan. Overall, the convertible bond market continues to exhibit a high degree of convexity with equity sensitivity of just under 47 per cent. There was a major new issue in the US in the shape of the convertible bond from Tesla, which was well received by the market.
Our portfolio holdings
Unless otherwise noted, all Information and illustrations are as at 21 May 2019.