UIC retains focus on opportunity-oriented investments
Constructive outlook for 2022
- Economic recovery, strong profit growth and a decline in the pandemic’s influence on market trends expected for 2022
Omicron variant: temporary deterioration in the coronavirus situation, but no fullscale lockdown
Monetary policy support to be scaled back while maintaining market stability
UIC reaffirms its moderately bullish risk positioning (RoRo meter at level 4)
Committee decides to establish an overweight exposure in industrial metals
Emphasis on equities and commodities in the UIC portfolio, while safe havens remain underweighted
RoRo meter confirmed at 4, risk position remains moderately bullish
At its last regular meeting in 2021, the Union Investment Committee (UIC) reaffirmed its moderately bullish risk positioning (RoRo meter at level 4). Only a few small adjustments were made in the model portfolio. Against the backdrop of improvements in fundamentals, the positioning in industrial metals was shifted to a slight overweight.The UIC had already increased the underweight in government bonds from core eurozone countries over the course of the month. The committee thus continues to focus on opportunity-oriented assets such as equities and commodities while remaining more cautious with allocations of assets to defensive segments.
This reflects the UIC’s constructive view of the upcoming new investment year. The committee believes that the global economic recovery will continue, albeit at a slower pace than in 2021 and potentially at different rates in different regions. Profit growth in the corporate sector is expected to remain strong. Advancing vaccination campaigns, effective medication and rising immunisation levels should usher in the transition from pandemic to endemic phase over the course of the year. As a result, the influence of coronavirus on the capital markets should begin to wane, although the coming winter months will be another stress test for economies and societies in the northern hemisphere. The UIC is of the opinion that, in the medium term, these effects will have a greater impact than the change in the direction of monetary policy (which has already begun), keeping the markets supported.
The constructive outlook is subject to the proviso that no geopolitical crises emerge (e.g. in eastern Europe) and that the pandemic situation continues to improve. At present, the UIC does not anticipate any lasting disruption to the capital markets in connection with either of these two factors, but will continue to monitor conditions closely and take preparatory steps as necessary. This also applies to the recently identified Omicron variant of coronavirus. There is currently no solid evidence to suggest that Omicron is able to bypass the protection provided by the existing vaccines. In addition, vaccine manufacturers have emphasised that they are able to respond swiftly to changes in the situation. It is therefore likely that the emergence of this variant will further exacerbate pandemic pressures this winter and prompt temporary reintroductions of stricter containment measures. However, the UIC does not anticipate a reimposition of full-scale national lockdowns and believes that developments will not ultimately prevent the transition from the pandemic to an endemic stage.
Economy, growth, inflation
Union Investment’s proprietary leading indicators have recently been pointing towards a stabilisation in the global economic environment. In the US, the recovery in the labour market has accelerated noticeably since October. Key employment metrics have improved significantly. In addition, the unemployment rate recorded another sharp fall, reaching 4.2 per cent. Over the course of 2022, unemployment is expected to move even closer to the pre-pandemic level of 3.5 per cent. The goal of maximum employment will therefore come within reach sooner than previously expected by Union Investment’s economists.
In Europe, several leading indicators – such as purchasing managers’ indices and the ifo Business Climate Index for Germany – have deteriorated. This is primarily a reflection of the impact that the pandemic is having on the assessment of current conditions. Expectations components, on the other hand, have remained relatively stable, suggesting that the business situation in the corporate sector (especially in the industrial sector) is robust. Macroeconomic data also stabilised in China, albeit at a weak level. The country’s government and central bank have taken initial steps to shore up the economy. This has reduced the risk of a renewed downturn. However, Union Investment’s economists expect that more extensive support will be required in the first quarter of 2022 and that the authorities will most likely provide it.
Meanwhile, inflation rates have remained high in almost all countries. Union Investment’s experts remain confident that inflation will come down significantly over the course of 2022 as year-on-year effects drop out of the equation, supply bottlenecks ease and economic growth slows down. Most importantly, no signs of broad-based second-round effects – typically a key driver of persistently high inflation – have emerged as yet. Overall, annual inflation rates in 2022 are therefore likely to be higher than expected on average, but this will be primarily attributable to strong upward price pressure in the very early part of the year. The Union Investment view is that inflation rates will drop to levels within the central banks’ target ranges by December 2022.
Monetary policy: central banks scale back support
The trend towards reducing monetary policy support has been cemented worldwide. Central banks around the globe are scaling back their support. The ‘smaller’ central banks are acting particularly decisively. Chile, for example, raised its key interest rate by 125 basis points in December. The Hungarian central bank also hiked its key lending rate, by 30 basis points to its current level of 2.4 per cent, although it is still buying bonds at the long end of the yield curve.
However, the tightening of monetary policy is now no longer limited to the ‘second-tier’ economies. Spooked by high rates of inflation, the Bank of England (BoE) became the first of the G7 central banks to raise its key interest rates. The reference rate in the United Kingdom is up from 0.1 to 0.25 per cent. In the US, meanwhile, the Federal Reserve (Fed) is scaling back the pace of its bond purchases more quickly than it had originally planned. Net bond purchases are now set to end as early as March 2022, which would pave the way for a first interest rate hike midway through the year. Union Investment economists currently expect the Fed to make its first move on interest rates in June, followed by two more by the end of 2022.
Inflation has not accelerated to quite the same extent in the eurozone, so the situation facing the European Central Bank (ECB) is less acute than for its counterparts in Washington or London. So it is no surprise that Frankfurt is giving itself more time to pare back support. Although bond purchases here, under the pandemic emergency purchase programme (PEPP), are also set to end in March 2022, the ECB is expected to remain an active player in the market and continue to buy paper. These purchases will be made under an older purchase programme (APP) or through the reinvestment of maturing bonds. In the case of the latter, the ECB also used its December decision to give itself greater flexibility in these actions, which should benefit Greek bonds in particular (as they are ineligible for purchase under APP). Nevertheless, the eurozone is still unlikely to see any interest rate hikes before mid-2024.
Fed to begin raising interest rates earlier than planned
Fed members are becoming more hawkish and now expect rate rises to be brought forward more strongly into 2023
Equity weighting within the asset classes
Fixed income: yields and spreads sliding again
The date of the last UIC meeting coincided with a high water mark for yields on ten-year German government bonds and US Treasuries. A steep drop up to the start of December (10-yr Bunds down by 17 basis points, 10-yr USTs down by 32 basis points) saw Bund yields maintain their general downward trajectory and an end to the trend of rising yields on US Treasuries. The latest central bank meetings and decisions did not trigger much in the way of movements in the fixed-income markets. For 2022, the view at Union Investment is that yields will continue ticking upwards on both sides of the Atlantic. The trend towards widening spreads also reversed. Both in the corporate bond segment (investment grade and high yield) and the periphery and EM government bond segments, around half of the increase in spreads that had built up following the low in November has been surrendered again since the beginning of December. Union Investment’s experts still see the greatest potential for falling spreads on the upper rungs of the risk ladder, but are currently looking for opportunities in other asset classes rather than bonds.
Equities: Omicron only briefly weighs on equity markets in the industrialised countries
The stock markets in the industrialised countries have once again demonstrated their resilience in recent weeks. The new Omicron variant of the COVID-19 virus joined what was already a daunting set of challenges (weak growth data, high inflation, loss of production due to disrupted supply chains, a fresh wave of coronavirus infections in Europe). After a brief setback, the markets rallied, and in the US they are already close to the all-time highs recorded in November. The Fed’s latest decision has removed one element of uncertainty. Money is continuing to flow into the markets in the expectation that the downside factors described above will gradually ebb away over the coming months and quarters and that corporate profits can therefore maintain their upward trajectory in 2022. With real interest rates deep into negative territory, high-yield investments remain in demand, and this means that setbacks are quickly taken as opportunities to buy. The stock markets in the emerging economies, on the other hand, saw a marked decline and registered new lows for the year. Omicron aside, this was primarily due to the ongoing slowdown in the pace of growth in China. The UIC has nevertheless maintained its positions in the equity segment.
Commodities: position in industrial metals position expanded
Omicron also caused a setback in the commodity markets. Renewed restrictions on global air traffic, for example, took the heaviest toll on the energy sector. Despite fears of a drop in demand, OPEC+ continued with its scheduled production hikes in December (supply stepped up by 400,000 barrels per day during the month). The European gas market proved largely immune to this trend. Sabre-rattling between Ukraine and Russia saw the price of gas in Europe rise to an all-time high. The UIC is taking advantage of the correction in industrial metals to slightly expand its position. The forward curve holds appeal for investors (backwardation), inventories are low and an improvement in credit-led demand is on the cards in China. Looking to the medium-term, industrial metals also stand to gain from the decarbonisation of the economy. Precious metals have taken a hit recently in the wake of rising real yields in the US, but remain the most attractive commodity sector from a fundamental perspective.
Currencies: little impetus
The fact that the Fed is winding up its ultra-expansionary monetary policy more quickly than the ECB was priced in to the currency market in November. Since then, the US dollar has largely held steady against the euro. Neither the Fed’s decisions nor those made by the ECB have given the currency pair any impetus in either direction. Unlike other major currencies, such as pound sterling and the Japanese yen, the euro has traded within a narrow range of late, although it has tended to appreciate slightly. The euro is expected to strengthen more broadly again as the drivers for the currency markets shift in 2022. The single currency is set to be bolstered by demand for NextGenerationEU bonds, for example, while support for the US dollar is likely to wane significantly as the capital markets switch their attention to the US fiscal deficit. For now, however, this is still not reason enough to open a position in the currency sector.
Convertible bonds: weaker of late
Volatility in the equity markets has meant that the last few weeks have not been easy for convertible bonds. Convertible bonds from the US made particularly significant losses, whereas their Japanese equivalents held relatively steady. There was a lot of pressure on Asian convertible bonds, especially those from the real estate sector. As a result of the slide, equity market sensitivities fell to just under 47 per cent and prices dropped again. There were further new issues, most notably from the US.
Unless otherwise noted, all information and illustrations are as at 17 December 2021.
Adjustment to the positioning from 11 January 2022
Today, the Union Investment Committee (UIC) has made an adjustment to the positioning of its model portfolio. The exposures to government bonds from core eurozone countries and the US were increased by 2.5 percentage points each. The liquidity required for these adjustments came in part from a reduction of the absolute-return exposure (-3.0 percentage points) and in part from cash holdings (-2.0 percentage points).
The adjustments have no impact on the portfolio’s overall risk positioning, which remains moderately bullish (RoRo meter at level 4).
Since the landmark central bank meetings in December, yields in the government bond markets have been rising strongly. Recent data showed ten-year Bund yields up by 30 basis points at minus 0.05 per cent – the highest level since May 2019. In the opinion of the UIC, the current price levels already reflect much of the changes in external conditions. The latest inflation data was once again up slightly on the previous set, but this trend has now probably reached its peak. ECB Chief Economist Philip Lane emphasised this week that medium-term inflation expectations were the most meaningful indicator and that he was not seeing any wage pressure in the eurozone at present. At the same time, long-term inflation expectations for the eurozone have come down slightly since the start of the year. The latest purchasing managers’ surveys also indicated that supply chain disruptions are beginning to ease. In the near term, the UIC thus sees limited potential for a continued rise in yields. It believes that this is a good time to collect profits on government bonds from core eurozone countries and to reduce the underweighting of these assets by 2.5 percentage points.
The US saw an equally strong yield surge in recent weeks. Market participants now expect that the Federal Reserve will embark on a relatively steep path of interest-rate hikes in the near future. The probability of a first interest hike in March is now deemed to be around 90 per cent. To put that into context: As recently as early December, this had not been expected to happen until June. All in all, four interest-rate increases have been priced in for this year. In addition, the debate about scaling back the bank’s balance sheet (quantitative tightening) has intensified significantly. The committee regards the market response as exaggerated and is using it as an opportunity to also collect profits on US government bonds.
Adjustment to the positioning from 21 January 2022
Today, the Union Investment Committee (UIC) decided at an extraordinary meeting to close the existing commodities positions and collect profits. As a result, the risk positioning is now neutral (RoRo meter at level 3).
This decision does not represent a change in the fundamental assessment of the conditions in the capital markets. The committee remains confident that opportunities currently outweigh risks, especially in higher-risk asset classes. The existing overweight in equities of 3 percentage points was therefore confirmed. However, in line with our expectations, trading has been more volatile in the first few weeks of 2022. The volatility arising from a positive fundamental trend paired with elevated yields is likely to persist for most of the year. This means that tactical adjustments will be required intermittently, but these can also unlock upside potential.
Today’s decision to neutralise the commodities position is such a tactical adjustment. The UIC continues to take an optimistic view of the outlook for this asset class, meaning that commodities should remain attractive over the year as a whole. But prices have climbed by around 15 per cent at index level since December 2021. In the individual sub-asset classes, various performance drivers have since improved. The industrial metal segment, for example, is benefiting from the fact that the Chinese central bank has loosened its monetary policy regime sooner and to a greater extent than initially expected. This supports the faltering Chinese real estate market and, by extension, industrial metals, which are closely correlated with this market. Precious metals also fared well despite the rise in real rates of return in the US. Activities aimed at hedging against geopolitical turmoil are likely to have been a contributing factor in this segment.
Given the combination of favourable trends for several performance drivers and the swift and encouraging response in prices, the UIC decided to take profits and neutralise the existing positions. More specifically, the weighting of precious metals was reduced by 1.0 percentage point and that of industrial metals by 0.5 percentage points. The liquidity that this freed up will go towards the cash position (plus 1.5 percentage points) so that it can be used to quickly seize investment opportunities that arise in the market at short notice.