Investment Outlook

Investment Outlook first quarter 2019



"Labor is superior to capital & deserves much the higher consideration"

Abraham Lincoln 1861 - part of his first State of the Union address

World economy

In our last investment outlooks, above all, we stressed the development of politically created uncertainties. It seems that these uncertainties have now started to have an effect on the real economy. Macroeconomic statistics still confirm expected growth in developed regions for 2019, but growth expectations have been revised downward over the past quarter. This has caused a sharp correction in the global equity markets of around 12% and has had a negative impact on corporate bonds. There are several examples of these politically induced risks. These are the two most noteworthy.

First, international trade restrictions. Many companies report lower sales or higher costs due to current government policies. The purchasing manager sentiment indices (PMI’s) for production companies in Europe and China have recently moved into negative territory while the less import and export-dependent service companies still report positive sentiment. The most discussed trade restrictions are those between China and the US. Both countries would seem to benefit from a new agreement. In particular China, with its heavy trade surplus against the US, has a lot to lose. On the other hand, the recent sharp loss of value on US equity markets may also motivate the American government to reach an agreement.

A second example is the protests in France. French government has indicated the protests will cost about 1% of GDP growth. President Macron is losing popular support and the implementation of the necessary reforms is losing traction. Thousands of demonstrators took to the streets in France, keep in mind, this is a country where even notaries sometimes go on strike. As a consequence of the revised economic outlook and of recent commitments by the French government for more social expenditures, it will be difficult for France to remain within the EU budget standards. This in turn has an adverse effect on the negotiating position of the EU towards others member states when urging them to stay within the EU budget norm. Italy in particular, comes to mind.

The basic scenario for 2019 is lower but positive growth. However, if a recession does occur in 2019, the institutions that we rely on to intervene have very few possibilities left. Central banks such as the ECB and BoJ already implement loose monetary policies and many governments suffer budget deficits. Specifically the US has a substantial budget deficit, partly due to the massive tax cuts in 2018. However, the US FED does have room to expand its monetary policy as a result of the interest rate increases during the past period.

Over the past year, the Laaken investment committee has worked from the premise that the chance of higher inflation exceeded the chance of lower inflation. This premise has been adjusted over the past period towards a more neutral stance, despite the fact that unemployment levels remain low. In Europe, real interest rates are still very negative. The risks associated with this normalising through higher nominal interest rates continue to loom.

Fixed income and liquidities - The Laaken investment committee continues its bond strategy with short maturities and low interest rate risk. The low risk, high grade portion of the bond portfolio is now largely held in cash. Despite the fact that inflation risks appear to have diminished, the risk remains that nominal interest rates will normalize. Sources of return are sought in individual selection of loans and bonds in foreign currencies such as USD and SGD. The FED raised the interest rate to a 2.25-2.5 bandwidth in December and indicated it expects two more increases for 2019. Outlook remains positive for variable USD bonds.

Equities - The allocation to shares and corporate bonds in the portfolios was reduced by between 4 and 6 percent over the last quarter. This resulted in a smaller correction in December compared to the very substantial losses on the worldwide markets. However, the rotation of technology to energy companies did lead to notable losses due to sharply falling oil prices.

Looking ahead, the portfolios started the year with a lower than average allocation to risk. For the time being, this allocation will not be reduced further. Operating profit growth expectations for all regions are positive, the markets are valued well within range of these expectations and the relative valuation with respect to bonds is strongly in favour of equities. We also maintain the positions in energy companies due to the attractive valuations on cash flow. Given the moderate inflation expectations and lower growth expectations, efforts are being made to reduce allocation to cyclical sectors in favour of less cyclical ones. Finally, we evaluate individual positions, of which, after the sell-off of the fourth quarter, the valuation does not seem to correspond with the underlying fundamentals. An example of this is Fresenius SE.

Listed Private Equity - Private Equity has plenty of room to add value in an environment of low interest rates and economic growth. The consideration in this asset class is maintained, but closely monitored because of the large inflow of money as a result of its popularity among investors.

Real estate - During 2018 the weighting in this segment was reduced to underweight. Given the looming risk for interest rate normalization, each position is evaluated. For some funds such as Unibail Rodamco, which was sold at the beginning of this year, that risk seems to have been priced in.

Precious metals - The position in gold remains an insurance, in particular against geopolitical risks and a possible recession.