Investment Strategy: A balanced picture

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Although macroeconomic indicators are still fairly weak, equity markets continue to be upbeat, extending the strong rebound that started early 2019. With central banks increasingly shifting towards more accommodative policies, investors deem a recession later this year less and less likely. This is in line with our expectation of lower growth, but no recession.

Against this background, the ABN AMRO Global Investment Committee reiterated its neutral stance on equities at its meeting on Thursday 21 March. Anticipating a weaker US dollar and given persistently low interest rate levels, the committee decided to further diversify the investment portfolio by taking a position in gold at the expense of cash. Within the bond part of the portfolio, the position in US mortgage-backed securities was reduced; proceeds were allocated to European covered bonds.

Weak economic indicators

The economic momentum continues to be weak. Earlier this month, ABN AMRO Group Economics lowered its 2019 forecasts for US growth. Weakness in Europa and Asia is likely to affect the US economy as well. The good news is that US consumer spending should continue to provide support to the economy. All in all, the global economic picture remains balanced. We do not expect the world economy to slip into recession this year. Instead, we continue to expect a moderate improvement in the second half of 2019.

Equity markets – rebound continues

Despite the slowdown in economic growth and adjusted outlook for company earnings, sentiment in equity markets remains upbeat. Investors take comfort in the fact that major central banks, including the Federal Reserve and the ECB, are refraining from further monetary tightening. The Fed, for instance, struck a remarkably dovish tone at its meeting on Wednesday. As expected, the Fed left interest rates on hold. The central bank also signalled that no more rate hikes were to be expected for 2019 – in line with our view that the Fed is shifting towards a more accommodative stance. Earlier this month, the ECB signalled it would refrain from rate hikes until at least the end of the year.

With central banks increasingly leaning towards dovish policies, investors are no longer concerned about the economy falling into recession later this year. In addition, political risks seem to have little impact on investor sentiment. Against this backdrop, we believe a neutral stance towards equities remains warranted.

Bond yields grinding lower

Yields on core government bonds, such as US Treasuries and German Bunds, are grinding lower. This is partly because of the deteriorating outlook for growth and inflation and partly because central banks seem determined to support the economy with loose monetary policy. Meanwhile, bond markets are sustaining this year’s rally in risky assets. Spreads widened sharply in the second half of last year, but have now returned to levels that are much more in line with an environment of low growth and low inflation. With economic risks currently balanced, we maintain positions in corporate bonds.

Emerging market bond spreads have also fallen. Local emerging market yields have declined and emerging market currencies continued to recover this year. We still see significant potential for emerging market currencies to perform well from here. In addition, emerging economies could prove more resilient than markets are pricing in. We therefore maintain our positive stance towards emerging market debt, in hard-currency sovereigns and corporates as well as local-currency bonds.

Reduction in US mortgage-backed securities

We decided to reduce our position in US mortgage-backed securities (MBS) by 50%. Reasons for scaling down our positioning include MBS’ sensitivity to economic conditions, which have been deteriorating in recent months. Another reason is that we are likely to see some weaker demand for MBS, as many professional investors already have substantial positions in this bond segment. Proceeds of the reduction in MBS have been allocated to European covered bonds. With spreads around 60 basis points, which from a historical perspective is quite generous, covered bonds offer an attractive alternative to (negative-yielding) government bonds to provide protection in the overall bond portfolio.

Although we have lowered our position in US MBS, we maintain our positive stance towards this bond segment, as it continues to offer stable cumulative returns and benefits from lower volatility compared to corporate bonds. Another argument speaking in favour of US MBS is that they are fairly immune to the possible fall-out of specific European issues, such as the situation in Italy and the upcoming European parliamentary elections.

Alternative investments

Within alternative investments, we continue to favour commodities and hedge funds. Within the commodity segment, we decided to put some cash at work by taking a position in gold. Our precious-metals analyst maintains a positive outlook for gold prices in 2019. The US dollar is expected to weaken later in the year, which represents a tailwind for gold prices (gold prices tend to rally when the dollar weakens). The Chinese yuan, by contrast, is expected to further appreciate. A higher yuan would reflect higher confidence in the Chinese economy; China is an important gold consumer. Moreover, interest rates are expected to remain low in the foreseeable future: this too would be beneficial for gold, given the negative correlation between interest rates and gold prices (gold is not paying interest; gold prices tend to rise when interest rates fall and vice versa). From a portfolio perspective, taking a position in gold is a way to achieve further diversification.

Hedge fund investments continue to be of interest, given the diversification benefits that a combination of hedge fund strategies can contribute to a portfolio. Hedge fund strategies also offer the potential to maintain performance even when other asset classes face difficulties.

Conclusion

Although economic growth is currently subdued, we do not suggest investors to stay on the sidelines. Our neutral stance on equities offers room for manoeuvre when economic conditions change. We continue to advocate a diversified investment approach that involves multiple (sub) asset classes and is aimed at striking the right balance between risk and return.

Global Investment Centre
Richard de Groot - Head Global Investment Centre
Chair ABN AMRO Global Investment Committee

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