Your questions, our answers
In our latest issue of Clear and Simple, our Portfolio Managers discuss the impact of the upcoming US presidential election on markets, their expectations for the EUR/USD exchange rate in the future, as well as what the Federal Reserve’s change in inflation target means for interest rates. They also look at the positioning of the Ethna-AKTIV in light of the somewhat turbulent times on the capital markets, before explaining ETHENEA’s view of the equity markets and how we implement this in the Ethna Funds. Finally, they discuss where we see opportunities to generate returns on the bond market given the low interest environment.
The US presidential election is drawing closer. What impact is this having/will this have on the markets? How are you preparing your portfolios for the following scenarios – Trump’s re-election or a change in administration with Joe Biden at the helm?
As was the case four years ago, the polls are again pointing to a very close election result. This year, however, if President Trump were to be re-elected, his policies, however unpredictable, would no longer come as a surprise. People have become accustomed to both the rhetoric and the political style of the present incumbent. If, however, the contender takes office, there is reason to believe that not only parts of Trump's tax reform will be reversed, but that more regulation will inevitably follow. These factors, together with the fundamental uncertainty surrounding a new president, suggest that a re-election of Trump is more likely to be positive than negative for the capital markets, at least in the short term.
However, in our opinion, the outcome of the election will not have a major impact on the markets in the longer term. In the next few weeks, it is important to prepare for the critical phase of the election campaign with its corresponding higher volatility. We are therefore adjusting our portfolios slightly anti-cyclically so that any temporary setbacks in the markets can be used for acquisitions rather than divestments. In addition, we are refraining from repositioning the portfolios with regard to the USD until the election results are known.
Over the last few months, the capital markets have been experiencing somewhat turbulent times thanks to the coronavirus crisis. How have you positioned the Ethna-AKTIV in light of this? And where do you expect to see future performance drivers?
We do not expect the turbulence of the past six months, either in positive or negative terms, to continue. However, what will remain are central banks and governments that will do everything they can to stimulate economic growth in the current environment. With this in mind, we are much more optimistic than we were three months ago. Of course, it is no secret that the biggest gains will come from equities, should a scenario with better growth figures materialise. Even in a positive scenario, we believe there is only a limited probability of sustained interest rate increases. This is why, in line with our multi-asset concept, we are currently overweight in equities, but continue to hold a neutral position in corporate bonds, which - due to the addition of some interesting high-yield bonds - still generates a relatively attractive return. While gold is currently consolidating after a significant rally, we expect prices to continue to rise in the long term. Currently, the Ethna-AKTIV has reduced its gold allocation to 5%, but is prepared to increase it again up to the maximum allocation of 10%.
What is your current view on equity markets and how do you implement this in the Ethna Funds?
If you sort through all of the relevant influencing factors that determine the current developments on the equity markets, then two points are undisputedly at the top of the list. Clearly number one is the monetary policy of the major central banks, closely followed by the fiscal policy of the most important developed countries.
With hindsight, the coronavirus crisis will probably be perceived as a much more significant watershed than we realise today. There is a nice banker's adage that humorously presents the context of current developments: "If you owe the bank one million euros that’s your problem. If, on the other hand, you owe the bank one billion euros that’s the bank’s problem." Applied to the global government debt, this year's monetary and fiscal packages will serve as a catalyst to - unofficially – break away from the idea of debt repayment. Repayment will simply no longer be possible. Admittedly, there have been doubts about this for some time. But now it is a certainty. Investors will have to free themselves from this mental anchor in order to successfully orientate themselves in the post-coronavirus financial world.
In this context, it is important to classify the strong and dominant adjustment processes currently taking place on the capital markets, which are affecting all asset classes
For the equity markets, there is currently a very supportive double put in place, which should reduce major downside risks. In addition to the courageous intervention of the central banks in the event of financial crises (originally referred to as the Greenspan put), the fiscal put on the real economic side was added in 2020 on an unprecedented scale. You don’t need much imagination to envisage a perfect interplay of the two elements over the coming years in an environment of zero interest rates, increasing social inequality, the now politically addressed climate crisis, and ongoing structural change.
Our strategic outlook for the medium to long-term development of the equity markets is therefore positive, although the effects below the surface will continue to be highly differentiated. Broadly speaking, the key trends of recent years should continue to move forward. In addition, taking into account possible further fiscal packages, the outlook for cyclical companies is much more attractive than it was recently.
The constructive long-term picture for equities has recently been supported by improving economic, fundamental and sentiment factors. As a result, both the Ethna-AKTIV and the Ethna-DYNAMISCH took advantage of the recent price setbacks on the equity markets to further expand their equity allocations.
What are your expectations for the EUR/USD exchange rate in the future? Did the recent drop in the USD have a negative impact on the portfolios of the Ethna Funds? How did you position the portfolios after the fall?
For us as bullish dollar investors with a corresponding positioning during the first half of the year, the strength of the USD at the start of 2020, particularly at the peak of the coronavirus crisis, made a positive contribution to performance. With the weakening of the greenback, exacerbated in particular against the euro by the unexpected agreement on the European fiscal package, the dollar position cost us performance. For the time being, our original assumption that the euro would continue to weaken has not proved true. As a result, we have reduced our exposure in both the Ethna-AKTIV and Ethna-DEFENSIV to zero and are waiting until at least the US election before entering into a new position. Looking ahead, there are both supportive and negative arguments for the development of the USD. While the twin deficit and, above all, the increased scope of quantitative easing measures are arguments against the USD, it will mainly be the relative growth advantage of the US and the almost certain return of political risk in Europe that will favour the dollar in the future. At the moment, however, the headwind is still too strong, so we will wait and see how things develop.
Given the current low interest rate environment, where do you see opportunities to generate returns on the bond market?
On average, investment-grade rated sovereign and corporate bonds have performed well this year. Both the Ethna-AKTIV and the Ethna-DEFENSIV have benefited considerably from this movement. However, there are also corporate bonds that have not yet recovered from the coronavirus crisis. Bonds issued by hotel chains, airlines, cruise liners, and shopping mall operators, as well as bonds linked to travel activities and events continue to trade at a discount. There will definitely be companies in this sector that will survive the current crisis. On a selective basis, and after thorough fundamental analysis, we will certainly find interesting opportunities here for the Ethna-AKTIV and the Ethna-DEFENSIV. The risk premiums for corporate bonds without an investment-grade rating are still above the pre-lockdown level. As recently as February, nobody expected this type of crisis, followed by a market collapse and a recovery in which there were some opportunities. Even though most bonds are currently offering low yields, attractive opportunities may still appear at any time on the bond markets, and we will then thoroughly assess the risks involved.
At its recent meeting in Jackson Hole, the Federal Reserve announced a change in its inflation target – moving from a fixed inflation target to an average inflation target. What does this mean for interest rates? And how are you positioning the Ethna Funds accordingly?
At its regular meeting on September 16, the Federal Reserve reiterated that in the future it will base its inflation management on average inflation. The average inflation rate is to be set at 2 %. However, there is no information about the period over which inflation will be calculated, leaving the central bank sufficient leeway. As inflation in the US recently dropped back well below 2%, a significant increase above the target level over a longer period of time is required. However, the central bankers expect inflation to remain below the target level until the end of 2023. Therefore, if this expectation is proven correct, it is safe to assume that short-term interest rates in the US will not be adjusted over the next three years.
On the other hand, other market observers expect that this central bank policy, in combination with the Fed's purchasing programmes and the US government's budget deficit, will lead to permanently high inflation in the long term. This could lead to a slight increase in 10-year or 30-year yields. However, the Fed's purchasing programmes should quickly limit or even reverse a significant increase. We also expect inflation to remain low for the foreseeable future. In their USD bond investments, both the Ethna-AKTIV and the Ethna-DEFENSIV focus on corporate bonds with medium residual maturity. Here, stable and solid profits can be achieved without having to worry about high price fluctuations. We are currently avoiding the uncertainties of long-term bonds and are focusing increasingly on equities in the Ethna-AKTIV and on high-yield bonds in the Ethna-DEFENSIV, where we are expecting higher returns.
Please contact us at any time if you have questions or suggestions.
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