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Asset Allocation update June

17 June 2019

The fact that bond yields declined further and the credit market continued to perform well provided a further boost. Moreover, markets did not panic about emerging markets, allowing bond yields on these countries to fall further. Our investment policy remains unchanged. We continue to hold an underweight in equities and overweights in credits and emerging market debt.

Global growth under pressure

Even without the trade war triggered by the US there would be plenty of reasons not to expect particularly strong growth. The effect of stimulatory US fiscal policy is coming to an end and balance sheets at central banks in the US, Eurozone, Japan, the UK and China are shrinking on balance. The Chinese authorities are being cautious about monetary stimulation due to the huge amount of debt accumulated over the past few years. Then there is the added impact of the trade war. It can clearly be seen in the crumbling manufacturing confidence and moderate growth, if not shrinkage, in global trade and industrial production. There is a risk of contagion to corporate investment, jobs and consumer spending. We have not yet reached that stage but there are signs that point to it, such as fewer orders for capital goods. And employment growth is slowing in the US and Eurozone. Remarkably, confidence among small businesses in the US and among consumers in the US and Eurozone remains very high. Yet all in all the global economy looks to be heading for growth levels at which it will be difficult for companies to generate earnings growth.

“Whereas a year ago we witnessed the advent of inflationary pressure, this now seems to have largely abated. ”

Low inflation keeping central banks active

Whereas a year ago we witnessed the advent of inflationary pressure, this now seems to have largely abated. In the US, inflation excluding volatile components such as energy and food fell to 2.0% in May, its lowest level in fifteen months. This core inflation dropped to 0.8% in the Eurozone. Investors also have extremely low inflation expectations. This demands a response from the central banks. The US Fed has already switched to cutting interest rates. The question remains as to whether the Fed will fulfil the market’s expectations of two to three cuts to interest rates before the end of the year. The ECB is in a more difficult situation, given that it has little room for manoeuvre to cut interest rates. Yet ECB President Draghi did recently say that all options for a more expansionary monetary policy, including the reintroduction of the bond-buying programme, had been discussed at a policy meeting.

Investment policy: low bond yields, cautious about equities

The investment climate will continue to be dominated by low bond yields in our opinion. Weak economic momentum, lower inflation and inflation forecasts, expansionary monetary policies and uncertainties surrounding trade wars, the Brexit and Italy’s budget will keep bond yields down. In which respect, incidentally, we believe the record low German 10-year bond yields of -0.24% to have gone too far. Having widened in May, credit spreads tightened again somewhat in June. Given the reasonably sound balance sheets at European companies, we believe that yields on investment grade credits offer sufficient reward for the risk taken. We are therefore positive about this asset class. We are also positive about emerging market debt. We do not foresee turbulence on the financial markets reaching such levels as to squeeze these countries’ currencies. The low levels of inflation in these countries have prompted a growing number of central banks to cut interest rates, or to decide against further interest rate hikes. We are negative about equities. A climate of low growth and low inflation makes it difficult for companies to increase their earnings. We believe that markets still assume growth will pick up in the second half of this year. However, there are few signs that this will happen, creating room for disappointment.

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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