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  Sticking to our equity overweight

Economic data solid, but surprising less

At the end of last year global PMIs were extremely strong. Since then they have moderated as have some other leading indicators. Overall, there are fewer positive data surprises in the US, while economic data in the eurozone and in Japan have disappointed. Thus, while the growth story still looks solid, it has been less supportive for sentiment towards risky assets. Meanwhile the shock of February, initially driven by the prospect of higher inflation, less accommodative monetary policy and higher bond yields, still seems to be lingering. We would not argue against gradually higher inflation, but we do not see this force strong enough to derail equities. But we are vigilant and stand ready to adjust our asset allocation.

Cut overweight in European equities, cautious on credits

We have been overweight European equities for some time, but Europe has lagged the US last year and in the recovery from the February dip when measured in local currency. While some fundamental factors still argue in favour of Europe, such as more attractive valuations, an economy that has cyclically more room to grow and profit margins which have more upside potential, some factors have worked in favour of the US. These include the weakening of the US dollar versus the euro, the strong upgrade in earnings expectations following the corporate tax cuts and the relatively small exposure to the technology sector in Europe. As we think these factors will continue to work in favour of the US in the short term, we have closed our relative European overweight.

“We have been cautious on credits for a while and recently returns have actually been negative.”

We have been cautious on credits for a while and recently returns have actually been negative. With low spreads and also a low spread to yield ratio, the rise in government bond yields has caused high yield to outperform investment grade, especially so in the US. Spreads are significantly below levels we expect in the long term. For now, default rates are low and companies are able to cover interest payments. But rising leverage has caused corporate health to stop improving. Ratings from rating agencies are stable in the US, but have deteriorated in European investment grade. In European high yield the ratings distribution has actually improved. As we expect the ECB to taper its purchases of government and corporate bonds after September, we are especially cautious on European investment grade.

Market outlook

For now we have kept our pro-risk stance. We are overweight equities, emerging market debt and real estate and underweight government bonds and European investment grade credit. We think the global economic outlook is favourable for risk assets. We are especially pleased with the resilience of emerging markets. In this environment of robust growth and modest inflation we expect corporate earnings to grow, supporting equity markets. However, we are watching inflation and stand ready to turn our asset allocation more in favour of a more reflationist scenario.

Disclaimer
Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation  Desk

Marius Bakker
Ivo Kuiper
Joost van Leenders

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