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Asset Allocation Update

Economic indicators continue to be positive, although they are no long exuberant, and first-quarter corporate earnings in the US were very good. This should have pushed markets higher, but there was also plenty to be concerned about. We are no longer seeing clear-cut factors that should be able to support a renewed rally in equities and are therefore more cautious. In a late-cyclical and slightly more inflationary climate, we recommend protecting investment portfolios more against inflation, specifically via inflation-linked bonds and commodities. We do believe that risk-taking is still being rewarded and remain positive about emerging market debt and real estate and negative about government bonds.

Most companies in the S&P500 have already published their results over the first quarter and this earnings season was very positive. As many as 80% of the companies succeeded in exceeding profit forecasts, in spite of expectations being high. In Europe, about half of the companies published surprisingly positive results, more or less in line with the average we have seen over the past few years. Yet the robust earnings season received a lukewarm response from the US market. The data of course painted a rosy picture due to the cuts to corporation tax, but investors attached great importance to the comments made by corporate management. Any hint that earnings growth could not be maintained at that level was immediately punished. Remarkably, European equities did make progress, but this was chiefly due to relief at the appreciation of the euro coming to an end.

“There was plenty to worry investors. ”

There was plenty to worry investors. Disagreement on import tariffs and investment opportunities between the US and China could yet spark a trade war. President Trump’s withdrawal from the deal with Iran could upset the oil market and lead to higher oil prices. And signs of growing inflationary pressure in the US pushed 10-year government bond yields to over 3%. While the huge US budget and current account deficits ought to be negative for the US dollar, it in fact succeeded in increasing in value. Investors mainly scrutinised the significant difference in yields between the US on the one hand and Europe and Japan on the other. A stronger US dollar and higher US bond yields are traditionally a poisonous combination for emerging markets. Emerging market equities managed to contain the damage, but currencies and bonds took a hit. In particular those countries with high current account deficits, such as Turkey and Argentina but also Mexico, were badly affected. We see this as specific to individual countries for the time being. In general, emerging markets have succeeded in reducing their current account deficits and increasing their currency reserves.

What does this all mean for our investment policy? Given the positive economic growth and the persisting credit cycle, we believe it is too soon to take cover in defensive asset classes. Yet a shift from a climate of robust growth and zero inflation to one of less exuberant growth and slowly rising inflationary pressure does necessitate an alteration to our investment policy: continue to take risk, but hedge against inflation.

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

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