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Asset Allocation update July

17 July 2019

This is against a background of persistently weak economic indicators and downward adjustments to corporate earnings projections. We do not believe that the equity markets can keep this up and have decided to maintain our underweight in this asset class. We prefer to take risk in credits and emerging market debt.

Manufacturers are losing confidence

Industrial purchasing manager indices around the world have been falling since the start of 2018. For a long time hopes prevailed that levels were high enough to still point to growth, but those hopes have since dissipated. The upturn on emerging markets earlier this year also proved to be of short duration. We have seen a synchronised global downward trend since April. The indices for both industrialised and emerging markets have dropped below 50, pointing to a contraction in the industrial sector. This is not yet the case in the services sector, which accounts for a much larger portion of the global economy, but these indices have also dropped considerably over the past few months. The composite leading indicator for the OECD region is also displaying a downward trend. There are still only a small number of countries in which the indicator is rising. The greatest risk to the global economy is that the weakness in international trade and industry, largely caused by the trade war between the US and China, spreads to corporate investment, jobs and consumer spending. There are already signs of this happening. Orders for capital goods are being squeezed, job markets are slowing somewhat and consumers becoming slightly less optimistic. We still expect the global economy to slow further.

“The ECB will not resign itself to low inflation, may cut policy interest rates further and also reinstate the purchasing programme for government bonds and credits. ”

Central banks not mincing their words

In a speech at an ECB forum, ECB President Draghi left his audience in little doubt. The ECB will not resign itself to low inflation, may cut policy interest rates further and also reinstate the purchasing programme for government bonds and credits. His remarks prompted markets to price in interest rate cuts of nearly 20 basis points to -0.6%, pushed down German 10-year government bond yields to the extreme low of -0.4% and led to sharply tighter spreads on peripheral Eurozone government bonds and on credits. Fed Chairman Powell also weighed in. Previous remarks from Fed policymakers had already led to speculation about interest rate cuts, but in a speech to US Congress Powell did little to temper speculation about a cut of 50 basis points at the end of July. We believe this size of cut to be excessive. On previous occasions when the Fed initially cut interest rates by 50 basis points, the equity market already stood at much lower levels and the economy was clearly heading for a recession. Incidentally, central banks are not just responding to lower growth, but also to low inflation forecasts and actual inflation rates. In the Eurozone, core inflation (inflation excluding the volatile food and energy components) is struggling to rise much above 1%. US core inflation stood at 2.1% in June, but if we exclude the rather artificial housing component this rate is also just 1.1%.

Investment policy: preference for high yield bonds

Expansionary monetary policies will keep bond yields low. Many government bonds are offering low or even negative rates, leading to a lack of enthusiasm for these on our part. Moreover, we believe that German 10-year government bond yields have dropped slightly too far. We therefore anticipate negative investment results. We are also cautious about equities. The recent rally was driven entirely by expectations of more expansionary monetary policies and hopes of an economic upturn later this year. Valuations have consequently increased. At the same time, the outlook for growth has deteriorated. Earlier this year, the number of downward adjustments to earnings forecasts by equity analysts had shrunk somewhat, but it has recently started to rise again. The corporate results over the second quarter could well be crucial. Equities could be squeezed if companies are less positive about their outlook. This leads us to be slightly negative about equities. We are seeking refuge in safe European credits and emerging market debt. Credits are profiting from the recent trend of companies not wishing to see a further deterioration in their credit status due to the prospect of a new ECB bond-buying programme. Emerging market debt is profiting from expansionary monetary policies in the US and the emerging markets themselves, as well as from the US dollar not strengthening.


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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