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Mid-year review – Positioning and outlook for H2
Global economic growth seems to slow down according to leading indicators. A lot of companies hinted at better expectations for the second half of the year after a difficult Q1. Trade tensions between China and the US have again put into question the H2 recovery that valuations of risky assets seem to be counting on. We expect the uncertainty to have a negative impact on business confidence and capex. Beneath the surface of hard trade rhetoric, supposedly for the protection of the American workforce and security, both parties are battling for technological dominance. In this battle, both parties are willing to suffer significantly more pain, before yielding. For this reason, we are prudent in our allocation to risky assets and prefer to hold well-diversified portfolios.
Within fixed income, the goal is to be well diversified in terms of modified duration, spreads and currencies. The balance of these three factors offers stability and potential in this disinflationary environment.
Within equities, selectivity is key. This is especially the case for Europe that is heavy with disrupted or structurally challenged industries and companies that are cheap for a reason. We clearly prefer to be invested in quality companies with attractive growth prospects.
With regards to the allocation framework, it is clear that we prefer to take more risk (risk premia) on the fixed income side and less on the equity side where we are currently underweight.
It is our view that this portfolio offers market conform returns in rising markets and offers some protection when risky assets fall quickly as was witnessed during the last quarter of 2018.
Although tempting due to the current low interest rate environment, be wary of cutting interest rate exposure, as it is an important contributor to portfolio diversification. Instead, look for opportunities across the globe. As long as strong inflationary pressures remain largely absent, quality government bonds clearly still provide a robust backbone to a portfolio. US Treasuries stand out in this regard, as the Federal Reserve has more scope to cut interest rates than other G4 central banks. Also the Canadian and Australian yield curves offer potential. From a medium to long term perspective, the risk-reward characteristics of corporate and high yields bonds do not seem that compelling at current valuations levels as we expect the economic backdrop to worsen over the next year(s). Local currency emerging market debt on the other hand does offer a decent yield to cope with some uncertainty over the medium term. In short, diversification is key in a fixed income portfolio, with a preference for low-risk government bonds.
We think listed real estate will continue to be an interesting asset class in a low rate environment. Moreover, the assets are almost not impact by tariffs or other potential geopolitical tensions?
Within equities, we still have a preference for US equities because of their bias toward higher quality sectors and companies. Equities from emerging markets might become more interesting if the US Dollar would lose momentum. For now we see a further strengthening of the dollar and hence are neutral on equities from emerging markets.