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UIC makes tactical adjustments

Environment is still uncertain

  • Risk factors are continuing for the capital markets, without any widespread easing of the situation
  • Russia’s blocking of gas supplies to eastern Europe is a warning, but a general gas embargo is not currently anticipated
  • Normalisation of monetary policy is largely reflected in the prices of securities at the moment
  • UIC is retaining its neutral risk positioning (RoRo meter at level 3) and looking for brief windows of opportunity

RoRo meter reaffirmed at level 3: risk positioning remains neutral

RoRo meter 4

At its regular meeting in April, the Union Investment Committee (UIC) confirmed its neutral risk positioning (RoRo meter at 3). The committee still believes that the capital markets are faced with a huge amount of uncertainty. The negative factors creating this uncertainty have not shown any signs of easing in recent weeks. This is particularly true of the war in Ukraine and the economic fallout, but it also applies to the high levels of inflation and to the latest wave of coronavirus in China. Against this backdrop, the UIC is increasingly adopting tactical positions so that it can capitalise on brief windows of opportunity. The latest steps taken in respect of equities, commodities and currencies reflect this effort to generate investment returns in a difficult environment by taking a tactical approach.

The blocking of Russian gas supplies to Poland and Bulgaria has led to setbacks in the stock markets. Rising interest rates are also taking their toll on prices. The UIC believes that Moscow’s decision is intended as a clear warning to western European countries, especially Germany. However, Union Investment’s experts do not anticipate that a broad-scale gas embargo by Russia is imminent. Such a raising of the stakes would have a far-reaching, adverse impact on the economy and capital markets. There is simply too much to lose on both sides: urgently needed revenues for the Kremlin and a key element of the energy supply for western Europe. Tensions between the parties are therefore likely to continue growing, but we do not expect the situation to escalate as far as a gas embargo or for the military action to spill over into NATO countries. So the fundamental situation has not changed.

Moreover, Union Investment’s experts do not believe that the yield rise seen in recent months will continue in the same vein. Our economists predict that inflation rates will plateau in the months ahead. The major central banks’ route to monetary policy normalisation should also become clearer. These two factors will probably cause yields to continue drifting upwards, but with greatly reduced momentum. The markets have already largely priced in a gentle uptrend of this nature.

The UIC has therefore decided on a small, tactical overweighting of equities from industrialised countries in the UIC model portfolio. Sentiment has recently deteriorated, the corporate reporting season is going well and the negative factors are unlikely to increase markedly, which means there is potential for a rally after the adjustments of recent weeks. The adjustment is therefore a short-term measure and does not indicate a fundamental reassessment of the situation. In the commodities asset class, the UIC increased the weighting of precious metals (to neutral) and, in return, scaled back the position in industrial metals (to underweight). The overall proportion of commodities therefore remains unchanged. Just at the start of April, the UIC opened a long position in Japanese yen against the US dollar and the euro. The fixed-income, absolute-return and cash positions have not been adjusted.

Economy, growth, inflation

There is no let-up in the war in Ukraine, which continues to be a major source of uncertainty both in the capital markets and in the real economy. Nonetheless, leading indicators are not yet pointing to an economic slump in either the US or the eurozone. In fact, the latest data points – such as the ifo Business Climate Index for Germany – show a weakening of the economy but were actually fairly stable overall. However, closer economic ties with Russia, greater geographic proximity and the higher dependency of some European economies on energy imports from Russia mean that economic growth is likely to suffer more in Europe than in the US this year. The US economy is in a much more robust shape, and has been for a while, putting it on a stronger footing.

In the near term, the divergence of economic growth east and west of the Atlantic will therefore increase further. For the US economy, Union Investment’s experts continue to forecast GDP growth of 3.1 per cent this year. By contrast, the prediction for the eurozone has been lowered to 2.5 per cent and the German economy is now expected to grow by just 1.6 per cent. However, in 2023, the divergence in terms of growth is expected to diminish again somewhat, provided that the war in Ukraine does not escalate further. Our economists believe that growth in the US will slow to 1.9 per cent next year, partly due to interest-rate increases by the Fed, while the eurozone’s GDP and Germany’s GDP are each expected to grow by 2.1 per cent. This also shows that the negative influences on the economy in the baseline scenario for Europe are not severe enough to choke off economic growth entirely.

The global economic situation partly depends on developments in China. The world’s most populous country is currently battling huge outbreaks of the Omicron variant of coronavirus. To contain them, China is likely to increasingly impose strict lockdowns at short notice in the next few weeks. This will hold back growth, especially in the service sector. Against this backdrop, Union Investment’s economists have lowered their forecast for 2022 by 0.5 percentage points to 4.8 per cent. However, the likelihood of succeeding with the zero-COVID policy has risen due to the countermeasures. Interruptions to production and international supply chains should thus be limited.

Meanwhile, inflationary pressure remains high in almost every corner of the world. Union Investment’s economists have responded to this by raising their inflation forecasts. Consumer prices are projected to increase by an average of 7.0 per cent over the course of 2022 in the eurozone and by an even higher 7.4 per cent in Germany. Our estimates for the US put inflation at 7.6 per cent. Inflation rates are then likely to fall back sharply in 2023.

Plan for monetary policy to return quickly to neutral interest rates

Scope for monetary policy action is much more limited in the eurozone than in the US, where generous fiscal measures under the American Rescue Plan have helped the economy to return to its pre-pandemic growth path. Disposable income remains stable thanks to the solid labour market and an upward trend in wages and salaries (especially at lower income levels). This means that consumer spending remains supported, even though households are no longer receiving government transfer payments. On this basis, the US Federal Reserve (Fed) is able to take a more robust approach to fighting inflation than the European Central Bank (ECB).

It benefits from the fact that the US housing market, which plays an important role in this context, is less sensitive to interest-rate increases than it used to be, because a large proportion of mortgages now have a fixed interest rate rather than a variable rate. So far, no tangible slowdown has materialised in the construction sector as a result of interest-rate hikes. The difference in the nature of inflation in the US also makes things easier for the Fed. The turbocharged reopening of the economy after the coronavirus pandemic initially created an imbalance between supply and demand in the US, which fuelled inflation. Demand-driven inflation is easier to control through monetary policy, because the central bank can take steps to slow down demand, whereas it has little influence on rising commodity prices.

The Fed’s signals have been very clear: It is serious about planned steps to bring down inflation. It wants to swiftly transition to a neutral base rate that does not drive growth. However, Union Investment’s economists believe that the expectations for interest-rate hikes that have been priced in by the markets for 2022 are overly ambitious. Instead, they expect the base rate to be raised by ‘only’ 200 basis points in total over the course of the year, including a rise of 50 basis points in May. Europe is a different story because here inflation is being driven up primarily by rising commodity prices, i.e. by supply-side factors. Consequently, the ECB’s ability to counteract this trend is limited. Nonetheless, more hawkish voices from within the ECB Governing Council are growing louder and Union Investment’s experts therefore anticipate two interest-rate increases from September 2022 onwards.

Monetary policy normalisation already priced in to a large extent

  • US base rate expected to reach 2.5% by end of 2022

    US base rate expected to reach 2.5% by end of 2022
    Sources: Bloomberg, Union Investment, as at 27 April 2022.
  • Pressure on valuations likely to diminish

    Pressure on valuations likely to diminish
    Sources: Bloomberg, Union Investment, as at 27 April 2022.

Fixed income: rise in yields already well advanced in ‘safe havens’

With inflation rates still running at a high level and central banks focusing ever more intently on combating inflation, the trend towards higher yields in the bond markets is continuing. In addition to the anticipated hikes in key interest rates, talk of the termination or tapering of asset purchase programmes has been putting downward pressure on bond prices in recent weeks. Union Investment’s experts expect to see further rises in yields over the coming months, particularly at the short end of the curve (two-year Bunds forecast to be yielding 0.7 per cent at the end of 2022; two-year US Treasuries 2.8 per cent). In the case of long-dated bonds, the majority of the rise is thought to be already behind us (ten-year Bunds forecast to be yielding 1.0 per cent at the end of 2022; ten-year US Treasuries 2.9 per cent). Following the rally in March, risk premiums in the spread segments have recently gone up again on the back of weaker equity markets, reinforcing the increase in yields in ‘safe havens’. In our view, high-yield bonds remain the most attractive sub-asset class as we do not currently anticipate any deterioration in credit ratings and this particular asset class is unlikely to be impacted by the termination of the ECB’s asset purchase programmes.

Equities: tactical opportunities in industrialised countries

Union Investment’s experts are using the recent dip in prices of equities from industrialised countries as an opportunity to slightly increase exposures in this segment. The adverse influence of rising nominal and real interest rates should diminish going forward, which, in turn, should reduce the likelihood of a price correction. Investors are currently holding only small exposures and the negative sentiment provides a countercyclical purchase signal. Notwithstanding concerns about economic growth, supply chain issues and input costs, the reporting season has started well, both in terms of the retrospective view of the first quarter and with regard to outlooks for the coming months. However, some question marks remain in relation to margin growth and customer demand in certain sectors over the medium term. The coronavirus situation in China also remains a risk factor, although signs of improvement have been emerging recently with regard to both infection levels and the containment measures imposed by the government to curb the spread of the virus. Nonetheless, it does not seem advisable to take up an active position in the emerging markets against the backdrop of the situation in China and the greater impact of higher energy and food prices on consumers in the emerging markets.

Commodities: correction in precious metals has probably run its course

Concerns about global car production recently caused the prices of quasi-industrial precious metals to drop. This correction has most likely come to an end now, as investors have adjusted their positioning significantly. Gold is the only metal in which investors are still holding considerable long positions. Robust demand from exchange-traded index funds and weak economic growth should keep precious metals supported. By contrast, industrial metals have fared well in recent weeks, despite the renewed spread of coronavirus in China and the stringent lockdowns imposed there in response. This commodity segment also still offers a relatively high geopolitical risk premium. Union Investment’s experts therefore decided to swap out short positions in precious metals for short positions in industrial metals. The oil price continues to be buffeted by news from Ukraine and China. Overall, global oil supply has remained solid, but there are significant differences at regional level. For example, the strategic oil reserves released by the US government are being used entirely for exports that are destined primarily for Europe, where shortages of oil products such as diesel are currently particularly severe. The results are high ‘crack spreads’ (difference between the price of crude oil and prices of refined oil products) and huge discounts on Russian oil. The halt of Russian gas supplies to Poland and Bulgaria is also sparking fresh uncertainty in the market, although both countries had recently already reduced their imports from Russia to a minimum. Union Investment’s experts ultimately regard this step by Russia as a signal towards Germany, because the Kremlin would be able to suspend a huge amount of the country’s gas supply by turning off the Nordstream 1 pipeline.

Currencies: Japanese yen expected to appreciate

Robust growth, a much more restrictive monetary policy approach by the Fed compared with other central banks, and the conflict in eastern Europe have continued to push up the US dollar in recent weeks. On a trade-weighted basis, the greenback has appreciated by around 6.5 per cent since the start of the year and by nearly 13.5 per cent since the end of May 2021. Compared with many other currencies such as the euro and the Japanese yen, sentiment towards the US dollar is quite bearish. It is likely that markets have already priced in the anticipated interest-rate hikes by the Fed to a large extent in both longer-dated US bond yields and US dollar exchange rates. Pound sterling is in a similar situation. This means that adverse pressures on other currencies, especially the Japanese yen, are more likely to diminish. Rising yields in the US paired with persistently ultra-expansionary monetary policy by the Bank of Japan (yield curve control) have caused the Japanese currency to depreciate by around 10 per cent against the US dollar since the start of March. Looking ahead, global concerns about economic growth should generally support the yen as a ‘safe haven’ while weighing on cyclical currencies like the euro.

Convertibles: volatile market environment

Convertible bonds reflected the volatile movements of the stock markets in recent weeks. However, the risk-reducing characteristics of this asset class meant that convertibles fluctuated within a narrower range, which allowed the global convertible bond market to deliver a relatively stable performance overall. Convertibles from the US weakened on average, while European paper fared best in relative terms. Equity market sensitivity in this segment is currently very well balanced at around 50 per cent. Only a small number of new issues were placed in the primary market.

 

Unless otherwise noted, all information and illustrations are as at 27 April 2022.

Adjustment to the positioning from 10.05.2022

Today, the Union Investment Committee (UIC) made two position adjustments. On the fixed-income side, an overweight exposure to US treasuries (plus 2.5 percentage points) was established, along with a corresponding underweight position in government bonds from eurozone core countries (minus 2.5 percentage points). In addition, the committee closed the underweight position in industrial metals (up by 0.5 percentage points) at the expense of cash.

This adjustment has no impact on the portfolio’s overall risk positioning, which remains neutral (RoRo meter at level 3).

In light of sharp rises in yields in the US (ten-year US treasuries now yield just over 3 per cent compared with 1.5 per cent at the start of the year), the committee believes that US treasuries offer upside potential in relative terms compared with ‘safe’ government bonds from the eurozone. While the US Federal Reserve has been shifting to a slightly more moderate tone, which suggests that an interest-rate hike of 75 basis points at the next Fed meeting has become less likely, the European Central Bank’s statements have recently become more and more hawkish.

Following a marked fall in prices since the end of April (down by 10 per cent), the UIC has furthermore decided to collect profits on the underweight (short) position in industrial metals and has neutralised the exposure.

The tactical overweight in equities was confirmed by the committee.

Adjustment to the positioning from 12.05.2022

Today, the Union Investment Committee (UIC) made two position adjustments. The overweight exposure to equities was scaled back (down by 1.5 percentage points), meaning that the overall equity weighting was neutralised. In addition, the committee closed the underweight position in energy commodities (up by 0.5 percentage points), which also brought the overall weighting of commodities back in line with the baseline allocation. As a result of these adjustments, the portfolio’s cash position has increased by 1 percentage point.

These adjustments have no impact on the portfolio’s overall risk positioning, which remains neutral (RoRo meter at level 3).

The tactical overweight in equities from industrialised countries has not proven successful over the past two weeks. US inflation data published on 11 May sparked a temporary rise in uncertainty that caused US share prices to cross a number of technical thresholds. Despite lower valuations and very negative sentiment indicators (that are generating countercyclical purchase signals), investors could see themselves forced to liquidate further positions as they reach the end of their risk budgets.

In the energy commodity segment, the market on both sides of the northern Atlantic should remain tight over the summer, especially for diesel and aviation fuel, due to uncertainty about a potential embargo on Russian energy exports to Europe. At the same time, positive roll yields on forward curves of around 2 per cent per month at present make it more difficult to maintain an underweight position.

Our positioning

UIC
As at 12 May 2022.
Market news and expert views

Market news and expert views: May 2022

Economy, growth, inflation and monetary policy – the monthly report ‘Market news and expert views’ will keep you informed about the latest developments and our expert assessments. It will also give you a comprehensive review of and outlook for the relevant asset classes.
(As at 2 May 2022)