Investment Outlook

Investment Outlook second quarter 2019

01-04-2019

2019-04-01

World economy

Towards the end of 2018 markets reacted sharply to lower growth, increasing interest rates and trade disagreements between the US and the rest of the world. Three months into 2019, these fears seem all but forgotten, helped in part by looser central bank policies. Equities showed strong gains during the first quarter. But macroeconomic indicators, such as the German production PMI, still disappoint. The ECB has now indicated that interest rates will be kept lower for longer and that the stimulus program will be continued. That is, in so far as that redeeming fixed income will be re-invested. The US FED has back tracked on earlier indications and now says no interest rate increases are expected in 2019, causing an inverted US$ interest rate structure. The ten year interest rate is now lower than the three month rate. Historically, that is an indicator for a pending recession. German ten year interest is back to negative, Dutch ten year interest is close behind. Monetary policy is expected to remain loose the rest of this year. The difference between government bond returns and equity dividend yield remains high, in favour of equities. The US president has assured markets that significant progress has been made in negotiations with China, aimed at reducing the US trade deficit, protecting US intellectual property and boosting the Chinese Yuan. However, as trade tensions flared during the last year, western companies started moving their supply chain from China to other low cost countries such as Vietnam. With this process already in motion, an abrupt reversal shouldn’t be expected, even if a trade deal is reached. We expect the Chinese production industry to be affected permanently. Meanwhile, China is back to plan A: stimulus. Since January 2019, China has reduced taxes for both consumers and businesses and continued its quantitative easing program. We expect more large domestic infrastructure projects in China, meant to keep unemployment low. This in turn can keep demand for commodities high. Finally, uncertainty about Brexit very much remains. A hard Brexit, soft Brexit, no Brexit or an extention are all still on the table. But while positioning is difficult with such diffuse scenarios, the situation also presents opportunities. A recent example is EasyJet Plc, trading at no more than the value of their airplanes.

Bonds and cash – During the quarter the duration of the fixed income was increased slightly, in part to reflect our more moderate interest expectations. Despite an inflation risk that appears low, the risk that the current negative real interest rates will recover at some point is clear and present. As markets have already absorbed a quite pessimistic interest rate scenario, chances of interest rates declining further seem low. Lower interest for longer reduces opportunities in fixed income, favoring allocation to cash.

Shares - The allocation to shares was stable during the quarter. In equities, a disconnection between growth- and value stocks has become increasingly apparent, with growth shares trading at levels that are difficult to justify and value stocks trading well below the levels one might expect. The central bank about-face earlier this year brought this disconnection to a new extreme. Fast growing companies that have never actually made a profit and with uncertain prospects of ever doing so, are trading at historically high valuations. Laaken does not invest in such companies. Other businesses may have shown both profitability, quality and impressive growth but are starting to trade at pretty expensive prices. Incrementally, Laaken has cashed in on positions such as Sartorius Stedim Biotech and Paypal. On the other end of the spectrum, quality companies such as Bayer and Fresenius have less growth potential but too low market valuations. We increased our positions in these companies slightly during the quarter. Finally, cyclical companies are usually rated as low quality investments. But as long as there is no recession, many of these businesses are cheap, trading at levels under the 2008 lows. Laaken has a limited allocation to these stocks with strict conditions with regard to leverage and management. Laaken is a long term investor. Over time, the quality of the business, primarily expressed as the total return on investment, is more important than the valuation. The investment committee continues to prefer high quality investments over growth stocks and cyclical companies.

Listed Private Equity - Private Equity has abundant possibilities 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 weight in this segment was reduced to underweight and part of the allocation was moved to infrastructure shares (Kinder Morgan, Brookfield Asset Management), providing a higher return for a similar risk. Real estate remains vulnareble to interest rate normalization, but together with listed infrastructure and private equity managers this asset class may have the most advantage of low interest rates over a longer period of time. The investment committee is currently evaluating a higher allocation to these segments.

Precious metals - The position in gold remains an insurance, in particular against geopolitical risks and a possible recession. Historically gold performs well in an environment with lower real interest rates, i.e. low interest and higher inflation.

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