Investment Outlook

Investment Outlook second quarter 2018

01-04-2018

2018-04-01

 

“There are two kinds of companies —  those that work to raise prices and those that work to lower them.”  Jeff Bezos, founder & ceo of Amazon

 

Investment outlook Second quarter 2018

 

World economy

Macro-economic statistics remain robust. For example: in all large economic regions consumer confidence is increasing, barring a slight recent decline, purchasing manager indices (PMIs) are at high levels and the high analyst consensus expectations are met in recent corporate results.

Since a few weeks, however, the quiet environment of gradually increasing share prices and ever-lower volatility has been exchanged for more turmoil on the financial markets. In addition to the tensions in international trade, less loose monetary policy or allusions to such policy are one of the causes. Whereas in the past market participants paid a great deal of attention to statistics on the money supply, which at the time was an important means for monetary policy, the interest rate policy and the bond buying policy of central banks in the US (FED), Europe (ECB) and Japan (BOJ) are now being closely monitored. Each word in the monthly explanation of central bank governors is analysed in detail. This is the vision of the Laaken investment committee for the American and European Central Bank:

The FED recently increased the interest rate by a quarter of a percent to a bandwidth of between 1.5 and 1.75%. The three-month LIBOR rate, with which banks can lend US Dollars to each other, has increased even further and stands at 2.3%. The expectations of the FED monetary policy committee are for two more rate hikes this year and three in 2019. Historically, the policy committee's own interest rate policy expectation is almost always too high. Unless inflation increases sharply, in that case interest may increase faster than previously indicated. Laaken estimates the risk of fewer rate hikes, given moderate inflation (expectations), greater than that the FED policy committee realizes or exceeds its own estimate. Thus far, the recent interest rate hike has mostly had an effect on short-term interest rates. With the absence of higher inflation expectations, the interest rate difference between ten-year and short-term bonds is decreasing. Since the beginning of 2018 the ten-year rate has indeed risen as well, but a large part of this increase has already been reversed by anti-free trade rhetoric and corrections in the stock market.

In March, the ECB emphasized less than previously that it is ready to step up the debt-buying program if they receive signs that the economy is performing less well. The Laaken investment committee expects the ECB to phase out the monthly purchase as from September, when the current program expires. Not in the last place because it starts to reach the limits of the buying program. For instance, the program has an obligation to hold less than 33 percent of the outstanding debt of a country.

 

Financial markets

Against this background of less accommodative monetary policy of both the FED and the ECB, risk-return ratios remain unattractive for a large part of the bond market. Despite the moderate inflation (expectations) or rising inflationary pressures, the low current rate of return in the event of an interest rate rise can be quickly offset by a price decline. In addition, bond yields with the current inflation levels should actually be higher.

Both in the US and Europe, risk premiums on corporate bonds are low.

The stock market, which is also characterized by high valuations, tighter monetary policy can also have a negative effect on prices. Real estate as a sector is considered to be the most sensitive here. Recent corporate results and the developments of the expectations of analysts, however, give reason for more optimism about the equity asset class.

 

Investment strategy

The interest rate risk is kept low within bonds. In the low risk part of the portfolios, the consideration between bonds with low credit risk and cash, in the light of the above view on monetary policy, remains in favour of cash. The allocation in cash therefore remains high. The allocation in corporate bonds has recently been reduced due to the low risk premium. Finally, part of the portfolio remains invested in short US dollar bonds. The structurally higher interest rate in US Dollar is considered attractive enough to include currency risk in this part of the portfolios.

The relative valuation of asset classes remains in favour of equities despite the high valuations. The portfolios therefore have a slight overweight in this category. The selection and valuation of individual shares is an important factor in this. The investments in real estate have been reduced over the first quarter.

The allocation in gold is maintained, mainly as insurance against persistent political risks and a possible increases in volatility. The diversification from the Euro into fundamentally strong currencies is maintained in spite of currency losses in recent months.

3 april 2018

LAAKEN ASSET MANAGEMENT N.V. © 2018

 

 

 

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