Outlook 2nd half of 2019
No end of the cycle in sight
Over the past few months, global growth expectations for 2019 have been continuously adjusted downwards. Although fears of a recession gained ground in the last quarter of 2018, the U.S. Federal Reserve’s change of course, as well as 2019’s unexpectedly more positive first-quarter reporting season, contributed to a significant easing of the situation.
Despite this, various leading indicators - such as the purchasing managers' indices, consumer confidence and, last but not least, an inverted yield curve in the U.S. - continue to point to a weakening of global growth. Against the backdrop of the ongoing trade war between the U.S. and China, investments necessary for growth are likely to be deferred to a future date. The pressure on corporate margins, which are currently at record levels, is also being exacerbated by both this uncertainty and the still tight labour market, particularly in the U.S. Admittedly, after the recent rapprochement, the signs for a short-term agreement have improved somewhat. Nevertheless, it would be optimistic to hope for a real breakthrough in the near future. Therefore, future adjustments to growth and earnings estimates are likely. However, given next year’s U.S. presidential elections, we assume that the President is likely to relent with regard to the trade war and that the Fed can be expected to take measures to counter the aforementioned adjustments. In short, we continue to expect moderate growth with low inflation. This is why we still rate the likelihood of a global recession in 2019 as low.
It is important to note that the global economy is still in the late stages of an economic cycle, whose end cannot be accurately predicted.
In our view, the following developments need to be closely monitored and the risk scenarios taken into account for the future. Until a solution is found, we believe a further escalation of the trade war remains the risk that is most likely to occur. In addition, in the event of a further growth slowdown, and given the announcements they have previously made, we consider it risky for central banks to make overly cautious use of their supportive monetary policy measures. And, of course, geopolitical risk should not be forgotten. The recent tensions between Iran and the U.S. show very clearly that demonstrations of power can quickly become military action.
Ethna-DEFENSIV: attractive opportunities still available on the bond markets
Since the beginning of the year, yields on 10-year U.S. Treasuries have fallen sharply and are currently sitting below the returns on debt securities with a 3-month maturity. As a result, the U.S. yield curve has become inverted, which is widely regarded as an indication of a possible economic downturn. Are we now facing an imminent recession in the U.S.? We believe not (yet), as the U.S. economy is still convincing with solid growth, steadily rising wages and manageable, and recently slightly declining, inflation. The yield curve anomaly is no doubt also largely attributable to the supply side. In the first four months of the year, the Treasury Department issued more than USD 4 trillion in bonds, of which only USD 177 billion were long-term 10- to 30-year bonds, or only 4.4% of total issuance. For this reason, the issuance behaviour of the U.S. Treasury may have favoured the inversion of the yield curve. As there are no plans to change the situation, this continues to justify low long-term interest rates. The 10-year German government bonds were also trading well below 0% again. The market is certainly paying a shortage premium here, as German debt is falling and the ECB has bought up 30% of all outstanding German government bonds. In view of the low growth and inflation environment, we do not expect the spread between yields on 10-year Treasuries and Japanese or German government bonds to remain at this level over the long term due to the global hunt for yields. Instead, we believe that the yield on 10-year Treasuries will move towards 1-1.5% over the next 12 months. Longer term, we expect yields on these government bonds to converge even further.
Corporate bonds continue to enjoy a significant yield premium over government bonds. Slower but positive economic growth, advantageous refinancing conditions and consequently the prospect of low default rates continue to make investments in corporate bonds attractive. Within our bond-focused strategy in the Ethna-DEFENSIV, we will continue to place considerable emphasis on high-quality corporate bonds for the time being. However, we still regard U.S. Treasuries as favourable. With the tight supply situation and the risks stemming from the trade conflict between the U.S. and China, we see investments in this highly liquid and secure asset class as very attractive.
Ethna-DYNAMISCH: a volatile summer for equities
The perceived long-term boom on the global equity markets was severely tested in 2018. The fourth quarter, in particular, was weak worldwide, with many indices posting losses of more than 20%, which, strictly speaking, mean the end of a bull market. However, the first quarter of 2019 was an impressive demonstration of the continued strength of the equity markets, with pessimists being penalized by strong price gains. This recovery was mainly driven by the supportive comments of the U.S. Federal Reserve. Within a few weeks, nervousness about rising interest rates had turned into an interest rate euphoria that caused global bond yields to fall sharply. However, following the gains since the beginning of the year, share prices have priced in a considerable amount of good news and valuations are somewhat more ambitious, at least for the short term. Developments in May have already shown that it is now somewhat tougher and more volatile on the equity markets than in the first few months of the year. We expect a similar environment in the coming months. Towards the end of the year, the stock markets could calm down again and be ready for a run of new highs. But until then, solutions must be found for the current trouble spots, in particular the trade war between the U.S. and China.
In the short term, there are still some dark clouds hanging over the equity market, which is why we are currently invested in more defensive sectors and equities in the Ethna-DYNAMISCH. We prefer companies with attractive valuations in the technology, non-cyclical consumer goods and healthcare sectors in particular, as these generally show relatively stable structural growth and are therefore in line with our long-term investment strategy. In addition, a number of well-established business models are under structural pressure. In Europe, in particular, these types of companies dominate the large-cap standard indices, and they have not shown any bottom-line profit and turnover growth at index level over the last 20 years. As we do not expect this to change for the foreseeable future, we see more potential in U.S. companies. During the summer months, we expect equity markets to be volatile and relatively weak, which could further depress cyclical equities in particular. Nevertheless, price setbacks can provide us with opportunities to build up equity exposure gradually, while profits can partially be realized during periods of better market performance. However, in the medium term, equities will continue to be the most attractive asset class and will still have a significant weighting in the Ethna-DYNAMISCH.
Ethna-AKTIV: flexibly taking advantage of opportunities
Following the escalation of the U.S. - China trade war in early May, concerns about the impact on global economic growth were back on the agenda. This resulted in an abrupt end to the upward trend on the global equity and bond markets that had dominated since the beginning of the year. Therefore, we expect an increase in volatility for the foreseeable future. To reduce equity-induced volatility and, at the same time, continue to benefit to an above-average extent from the falling U.S interest rates we identified in our baseline scenario, we believe it was necessary to both reduce equity exposure and further extend duration in the Ethna-AKTIV. We did not need to adjust our globally-focused and robust bond portfolio at single bond level. This allocation, which accounts for almost 80% of the portfolio, will still serve as the core of the portfolio.
As mentioned at the outset, as we still believe that the probability of a recession occurring in the coming 12 months is remote, we only intend to keep our equity exposure at this low level for the short term. As soon the uncertainty surrounding the trade war eases, we plan to increase the equity exposure again. In an environment of globally low interest rates and moderate growth, there are likely to be few alternatives to equity investments in the future. In the long term, this will probably result in significantly higher valuation multiples. Assuming that the tariff disputes are resolved, we can even envisage new annual highs over the course of the year. We believe that the Ethna-AKTIV’s gold allocation will become increasingly important and attractive due to low real interest rates. After years of sideways consolidation and an increasingly accommodative interest rate policy, it was only a matter of time before the price of the precious metal broke out and, in our view, a price increase towards new all-time highs is becoming more probable in the long run. In the FX market, the appreciation of the greenback against the euro within the next six months is the most likely scenario for us. We expect that the U.S. will continue to grow faster than Europe and that Europe's unresolved political problems will continue to weigh on the currency. That is why we have overweighted the U.S. dollar position in the fund’s currency bucket. Having benefitted from the sharp decline in interest rates over the last nine months, not only in the bond portfolio but also via duration overlay, we are taking the profits generated by the overlay and will remain neutral for the time being. In the long-term, however, we expect interest rates to continue to fall.
This year will also bring a number of developments and events for which the Ethna-AKTIV, with its carefully diversified core portfolio and flexible and active investment strategy, is well prepared. Liquidity and independence from benchmarks will give the fund the freedom it needs.
Please contact us at any time if you have questions or suggestions.
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