Union Investment Committee confirms neutral risk positioning
UIC portfolio: relative positions dominate
RoRo meter still at 3, Risk positioning remains neutral
The Union Investment Committee (UIC) is maintaining its neutral risk positioning (RoRo meter at level 3) and has reaffirmed all weightings in the model portfolio. The committee therefore continues to have a preference for relative positions. This translates into the overweighting of higher-yielding fixed-income paper (investment-grade corporate and periphery bonds) and equities on the one hand, and the underweighting of commodities on the other. ‘Safe havens’ are also underweighted. This approach also proved its worth during the softening of the markets in recent days.
The UIC believes that the positive fundamental trends are intact and providing support for risk assets: The global economy is recovering, scientists are making progress on tackling the pandemic, and monetary and fiscal policy are stimulating the economy. However, the uncertainties have, if anything, increased. Political issues, such as the US presidential election and the Brexit negotiations, are increasingly taking centre stage. It is possible that neither candidate will emerge as the clear winner after election day in the US. If one of them does not accept the result, the markets would see increased volatility.
At global level, there has been no let-up in the pandemic. However, significant progress is being made (e.g. more tests and better treatment methods). This, combined with the broader range of instruments at politicians’ disposal, leads the UIC to believe that strict lockdowns like those implemented in the spring are fairly unlikely.
Economy, growth, inflation
The global economy is currently shifting to a flatter recovery. This creates the potential for disappointment regarding growth forecasts going forward. Such tailing off of economic momentum after a strong upturn is fairly normal. But there are other factors at play too. It is becoming increasingly improbable that a decision on extending the economic support (‘Phase 4’) will be reached in the US before the election, which means a major source of support will disappear. This illustrates a global trend as well. In the spring of this year, governments and central banks were very quick to introduce extensive stimulus packages. Although this support remains in place and can be extended even further if necessary, the scope will probably be reduced compared with the current programmes. Economists and capital markets call this ‘peak policy’: The stimulus is still there but diminishing.
Monetary policy likely to remain loose for some time
The same applies to central bank policy. The US Federal Reserve formally adopted its new strategy at its most recent meeting. In future, interest rates will continue to be regarded as being at an appropriate level until maximum employment is achieved. The Fed will also allow inflation to overshoot its target for a while. Interest-rate hikes are thus a long way off and unlikely to make a comeback until 2023 at the earliest. However, the US central bank wants to maintain as much flexibility as possible with regard to its other instruments, such as moving the function of the asset purchase programme away from support for financial conditions and towards classic economic stimulus.
In Frankfurt, meanwhile, the European Central Bank (ECB) did not decide on any changes. However, it does appear concerned about the strength of the euro. Although the ECB’s remit does not extend to managing the exchange rate, it is arguing for a move towards a further loosening of monetary policy given the deflationary effect of a strong euro. However, it now has little room for manoeuvre. According to our experts, the ECB has few options beyond verbal intervention and a lowering of the deposit facility interest rate. We believe that expansion of the bond buying programme is unlikely at present.
Chart of the month: Peak policy'- further stimulus, but less than before
Equity weighting within the asset classes
Corporate bonds and eurozone periphery paper remain supported
The central banks’ expansionary monetary policy remains a crucial factor for the bond markets. Paired with a cyclical recovery, the central banks’ greater tolerance of inflation is likely to cause yield curves of core eurozone government bonds to steepen even further. Paper from the eurozone periphery, on the other hand, should remain well supported by the ECB’s asset purchases. Limited issuing activity in the periphery countries should furthermore result in a reduced supply of new paper in 2021. Corporate bonds also remain in demand, both from the ECB and from investors seeking attractive returns. In the autumn, discussions about debt relief for weaker emerging markets are likely to intensify, which will limit the potential of EM bonds.
Setback for equities amid rising risks
After key US indices recorded highs at the end of August, September brought a correction in the equity markets. Tech stocks particularly came under increased pressure, having previously risen sharply. The correction was driven by several factors, including rising coronavirus infection rates around the world, temporary issues with the development of a vaccine, weaker economic data, a renewed rise in geopolitical tensions and uncertainty in connection with the US presidential election. Over the coming weeks, these factors will continue to influence market movements. But the ‘hunt for spreads’ will generally remain a source of support for the global equity markets. Companies are making good progress in adapting to and coping with the current crisis, and profit expectations therefore continue to improve.
Anticipated recovery already reflected in commodity prices
In the commodities markets, conditions continue to normalise. Inventory levels in the energy sector (crude oil, oil products, natural gas) are falling steadily. Demand remains weak, as evidenced by dwindling premiums on physical oil and low refinery margins. The situation on the supply side is stable. Industrial metals have been well supported by the ‘usual’ stimulus from China, but this effect is likely to diminish going forward. In addition, investors are predominantly holding long positions in industrial and precious metals, which is curbing the upward potential of both segments. The appetite for gold and silver among ETF investors seems to have been sated for the time being.
Euro remains favoured
In future, the euro should benefit from further steps toward a fiscal union and greater integration at European level in general. But the ECB is monitoring the appreciation of the euro and its implications for inflation. Over the coming weeks, the upcoming presidential election in the US will increasingly dominate what is happening in the currency markets. We expect the US dollar to remain weak in the medium term due to the continuing rise in the US twin deficit, the flatter US yield curve and the Fed’s stated willingness to tolerate a higher level of inflation. Negotiations between the UK and the EU have been sluggish and the little time remaining will – at best – be enough to agree a skeleton trade deal. A hard Brexit is becoming more likely. This should put pressure on pound sterling. The Japanese yen will probably depreciate in 2021 against a backdrop of economic recovery.
Volatile times for convertibles
The turmoil in the equity market also had an impact on the market for convertible bonds. Over the past four weeks, this segment delivered a neutral performance overall. Equity market sensitivity remained at around 52 per cent while valuations continued to rise. A number of new issues were placed, especially in the US. They were met with good take-up in the market.
Unless otherwise noted, all information and illustrations are as at 22 September 2020.