Investment Outlook

Investment Outlook second quarter 2015

02-04-2015

2015-04-02

“That is simple my friend: Because politics is more difficult than physics.”
Albert Einstein, 1946

In our last outlook in the beginning of January we expected the U.S. to continue its outperformance and stated that Europe would be helped by the Dollar strength, but remained less attractive due to political risks. Over the quarter we were surprised by the Swiss National Bank dropping the peg between the Euro and the Swiss Franc on January 15th, the large outperformance of the Euro area stock markets and the quick response in the market to the Quantitative Easing program from the ECB. Our model portfolios generated very high returns over the first three months, equal to two years of expected average return. Paired with a rise in volatility and increased dependence on political decisions this makes for an uncertain environment.
We are going through unprecedented times. Central banks in developed markets have increased their balance sheets from four to eleven U.S. Dollar trillion in the past seven years. The announced ECB bond buying program implies the central bank plans to buy three billion Euro worth of bonds every business day until September 2016. The FED stopped their quantitative easing, but is rolling over the maturing debt into new securities. Assuming an equal distribution of securities held outright with a maturity up to five years this would imply the FED is still buying almost one billion U.S. Dollar of bonds every day. In combination with the wall of liquidity, this supports high valuations in the market for both fixed income and equity. We expect this to continue during the current year; but we’ve used this market appreciation to decrease risk in the portfolio due to a reluctance to accept this as a “new normal”.
Mainly due to recent stronger data from the European economy, consensus economic growth expectations for the world increased slightly at the end of the first quarter. However the 2015 expected world GDP growth remains below 3%.
In Europe, the economy is enjoying tailwind from the strong U.S. Dollar and lower oil prices. Unemployment remains high, but is declining, sentiment indicators are generally in positive territory, retail sales are rising and loans to non-financial corporations are increasing with banks growing their balance sheets. Structural and political issues are the main concern for the European market: government debt to GDP ratios have declined only slightly, Italy and France seem reluctant to reform, pro-default parties are gaining popularity in some of the periphery countries and the risk of Russia looking for more international confrontations as internal problems remain, is still present.
The U.S. economic statistics disappointed, but we remain positive on the development in this region and do what most Dutch tend to do, blame the cold weather. Consumers seem to be saving instead of spending the money they have saved on lower gasoline prices. With consumer confidence at the 2007 level for the first time since then, we remain patient and expect the economy to continue its moderate performance. In Asia, we expect China to live up to their lowered growth expectations of 6-7%, but are vigilant for negative surprises. We remain invested in Japan to benefit from the reforms. Singapore remains attractive and is performing well. Latin America remains our least preferred region, mainly due to political uncertainties and mismanagement.


Asset Allocation
Fixed income and equity markets in Europe have rallied and price to earnings ratios in the U.S. and Europe are at comparable levels. Compared to German government bonds yield on 10-year fixed income is almost 2% higher in the U.S. where a short term rate increase is already anticipated.
Taking into account current valuations of our other asset classes, we continue to see most value in equity investments, but remain only slightly overweight in risky assets with the main emphasis on dividend paying defensive stocks in U.S. and Switzerland. With current valuations and political risks we are currently reluctant to increase risk further.
Within bonds we focus on corporate bonds to obtain some yield pickup. Durations are relatively short in U.S. Dollar and longer in Euros. We used the sell-off in oil related bonds to pick up some exposure in this segment. We currently hold a higher percentage in liquidities to bring down overall risk and retain flexibility in case of a sell-off.
The two largest currency diversifications are U.S. Dollar and Swiss Franc. We remain positive on the U.S. Dollar as the difference in risk free yield between European and U.S. is historically large. The value of the U.S. Dollar has risen significantly the lasts months, we expect this to continue at least until FED actually raises rates. The Swiss Franc positions in the portfolios are maintained. This is a safe-haven for investors and most of this exposure is in export related stocks which can function as a hedge in case of an unexpected decline in the currency.

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