Union Investment Committee remains moderately bullish
Opportunity-oriented approach to the last few trading weeks of 2021
Pandemic on the rise again in the northern hemisphere, but widespread national lockdowns seem unlikely
Macroeconomic data is improving and supply bottlenecks easing slightly
Inflationary pressure remains high, but is expected to wane in 2022
UIC confirms moderately bullish risk positioning (RoRo meter at 4)
RoRo meter confirmed at 4, risk position remains moderately bullish
At its scheduled meeting in November, the Union Investment Committee (UIC) did not make any adjustments to its investment policy. The moderately bullish risk positioning (RoRo meter at level 4) was confirmed and the model portfolio was maintained unchanged. At the start of the month, the committee had shifted the exposure to equities from the emerging markets (EM) from underweight to neutral and at the same time extended the overweight position in equities from industrialised countries. The UIC is therefore going into the final trading weeks of the year with an opportunity-oriented approach, as reflected by the equity positioning, an overweight exposure to commodities and an underweight in safe-haven bonds.
This positioning is based on a constructive assessment of the economic environment. First and foremost, the UIC remains optimistic about the outlook for economic growth. Supply bottlenecks are currently still holding growth back to an extent. But these distortions should dissipate over time, not least because of seasonal effects such as a dip in consumer spending on goods after the Christmas period. The new year should bring opportunities for the economy to catch up with pent-up demand. All in all, the economic cycle thus remains intact and there are no signs of a slump in growth.
The UIC is monitoring the renewed rise in coronavirus infections very closely. Although the spread of the pandemic is likely to intensify in the northern hemisphere, the committee does not anticipate a reintroduction of national lockdowns encompassing the vaccinated population in major economies, thanks in large part to the well-advanced vaccination programmes in these countries. After the current winter season, the transition from a pandemic to an endemic situation should be within reach, at least in the industrialised countries, according to the UIC. As a result, the influence of COVID-19 on the capital markets is likely to wane going forward.
The high profitability level in the corporate sector, as underlined by the recent reporting season for the third quarter of 2021, remains a strong driver for equities. A rise in share buyback activity and the prospect of dividend increases are also supporting the stock markets.
Economy, growth, inflation
Economic data – for example the latest US labour market and retail figures – improved a little in recent weeks. This shows that the economy has learned to cope reasonably well with elevated infection rates, as long as no strict and widespread social distancing measures are imposed. Nonetheless, economic growth is not entirely immune to the growth in infections. Union Investment’s economists therefore predict that growth will slow down over the coming winter months, but that the fast-approaching new year will bring a fresh upturn. The easing of supply bottlenecks should trigger catch-up effects in many economies. Germany’s heavy focus on manufacturing means that it could be a major beneficiary of this trend.
Inflation remains the dominant influencing factor for economic growth and capital market conditions. Last month, inflation rates in the US and in Germany climbed above 4 per cent. Alongside pandemic-related factors, energy prices are proving to be the main driver behind the persistent rise in inflation. Union Investment’s economists have taken account of this trend and have raised their inflation forecast for the US for 2022 to 3.7 per cent, while inflation in the eurozone is expected to be 2.4 per cent. However, they anticipate that, as year-on-year effects and supply chain disruptions subside and energy prices fall again, inflation will settle down, especially in the second half of the year.
Monetary policy: the cycle has turned
Following a tightening of monetary policy by various smaller central banks in previous months, the US Federal Reserve announced at its November meeting that it would begin to scale back its asset purchases. The monetary policy cycle has therefore already turned. The Fed’s tapering plan envisages a reduction of purchases by US$ 15 billion per month provided that the economic outlook is sufficiently robust. If the plan goes ahead as scheduled, net purchases should be reduced to zero by mid-June 2022. This would give the Fed the necessary flexibility to raise interest rates relatively soon. Union Investment expects to see a first interest-rate hike in the US at the end of 2022.
In the eurozone, the economic upturn has been weaker and inflationary pressure not quite as high as in the US. The European Central Bank (ECB) will therefore proceed with a little more caution. To begin with, the focus will be on the future of the pandemic emergency purchase programme (PEPP), with a decision on this matter scheduled for 16 December. Union Investment expects that the programme will be terminated, but that asset purchases will continue at a reduced volume. It seems unlikely that the ECB will raise interest rates before the end of 2024. The turnaround in monetary policy is thus being conducted in a manner that should not be detrimental to the markets.
Fed begins to taper – capital markets price in interest-rate hikes
Net monthly purchases
Survey of fund managers on the expected number of interest-rate rises in 2022
Equity weighting within the asset classes
Fixed income: diverging yield trends for government bonds
The trend towards higher yields on US government bonds remains intact, despite a setback in the wake of the Fed meeting in early November. However, paper with longer residual maturities has not yet reached the yield highs seen in October. The continued rise in yields on short-dated bonds caused the US yield curve to flatten further. Rising numbers of new coronavirus infections, meanwhile, halted the slide in the price of German government bonds, which are considered a safe haven investment. Yields on two-year paper have fallen by 15 basis points since the beginning of November, while ten-year bond yields have slipped by 20 basis points. For 2022, Union Investment expect yields to continue ticking upwards on both sides of the Atlantic. The recent hunt for safe haven investments has perpetuated the trend towards higher risk premiums (spreads) on peripheral and corporate bonds. Spreads on emerging market bonds denominated in hard currencies have been on a bumpy but ultimately sideways ride since the summer. Emerging market bonds and high-yield paper are considered to have the biggest potential for narrowing spreads.
Equities: markets shake off downside factors
Weak growth data, high inflation, a fresh wave of coronavirus infections in Europe and disruptions to production due to supply chain issues – equity markets are facing a long list of challenges but are proving exceptionally robust in the industrialised countries. Corporate profits will continue to rise in 2022 if these downside factors gradually dissipate in the coming months or quarters as expected. Together with further strong corporate data and prudent actions by the central banks, this will encourage further inflows into the markets With real interest rates deep into negative territory, high-yield investments remain in demand, and this means that setbacks are quickly taken as opportunities to buy. In the emerging markets, the recovery that began in October continued, which prompted us to close our underweight position in the region at the beginning of the month. We need to tread carefully, however, as Beijing’s regulatory interventions in China are likely to lead to a general markdown for the affected companies over the longer term.
Commodities: sharp swings in precious metals
Precious metals initially rallied significantly in November, after having lagged well behind the cyclically sensitive commodity sectors for much of the year due to the trend in US real interest rates and to production constraints in the automobile industry. However, news of a fresh lockdown in Austria and concerns about a further wave of coronavirus in Europe sent prices tumbling down again. These factors also accelerated the fall in energy prices, which had been triggered by an improvement in the gas supply situation in Europe, talk of tapping into strategic oil reserves and the first signs that bottlenecks were easing. Nevertheless, prices for oil, gas and electricity are still well above the levels they were at a year ago and are the main driver of the current high rate of inflation. Despite growing pressure from the US, the OPEC+ countries are sticking to their plans of stepping up supply each month by 400,000 barrels per day, although some of the oil-producing countries are unable to increase their exploration to the planned extent. The correction in cyclical commodity prices also caused roll yields to fall again, from 13 per cent to 8 per cent in the energy sector and from 6 per cent to 1.5 per cent for industrial metals. Overall, however, commodity prices held up well in the face of a strengthening US dollar.
Currencies: euro under pressure - but opportunities lie ahead
The fact that the Fed is winding up its ultra-expansionary monetary policy more quickly than the ECB gave the US dollar an additional boost. And the latest comments from the central banks suggest that the pace at which their asset-purchase programmes are scaled back could diverge even further in the medium term. The continued weakening of global growth has dealt a blow to the euro, as has the recent rise in new coronavirus infections in the single currency area. With the exception of Austria, however, new lockdown measures have so far been introduced only on a regional basis. The euro has also depreciated further against other important currencies of late, including pound sterling and the Japanese yen. The UIC is not putting its eggs into any particular currency basket at the moment because it remains hard to predict how the trajectory of the pandemic will affect currency movements, at least in the short term. However, the euro is expected to strengthen again as the drivers for the currency markets change in 2022. The single currency is set to be bolstered by demand for NextGenerationEU bonds, for example, while support for the US dollar is likely to wane significantly as the capital markets switch their attention to the US fiscal deficit.
Convertibles: Sideways trend
The convertible bond markets have recently run out of steam after going on a strong run in October. They have seen only limited benefit from the healthy performance of the equity markets. Convertibles from the US have fared particularly badly in recent days. The average equity market sensitivity remains unchanged at around 51 percent and is therefore well balanced. Prices are also largely stable. Activity in the primary market picked up strongly again, particularly in the US, and was met with strong demand.
Unless otherwise noted, all information and illustrations are as at 23 November 2021.