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A cold winter ahead?

Equity markets have been subjected to great uncertainty again this autumn, the causes this time around being the prospect of a cold winter, the escalating conflict in the Middle East and an oil price above $30 a barrel. Although we recognise the pattern of such weakness, the reasons given for it change from year to year.
At the same time, economic conditions have by and large been favourable in recent months. The long-awaited economic downturn in the US is in the offing, and the recovery in Europe has become established as a relatively stable economic upturn.
In our view, a soft landing in the US has been on the cards for some time. It should actually be possible for Alan Greenspan to leave short-end rates unchanged over the next six months. Although under these conditions corporate profits will no longer grow as vigorously as in past years, US corporate profit projections for 2001 remain in double-digit territory.
The opposite should be true for euro-based companies. The economy in the Euro zone continues to be very robust. Although some indicators were temporarily lower than projected, we expect economic momentum in Europe to continue at an unabated pace. We have made no change to our growth projection of a good 3% for 2000 since the start of the year and still see no reason to do so.
We still see the possibility of the ECB carrying out one or two more rate hikes over the coming months.
As regards our investment strategy, this means that there should be upside potential for equities following the corrections in September and October. The economic conditions underlying equity markets do not seem to be that bad, considering that economic growth on both sides of the Atlantic could well total around 3% again next year. The uptrend in profits of recent years should thus continue.
We expect interest rates to cause only minor disturbances, as rate hikes are not an issue in the US, while in the Euro-zone one or two further slight rate hikes by the ECB have already been priced in. Ten-year government bonds could well continue to trade within a range between 5% and 5.5%.
Transforming all this into an asset allocation for a Euro-zone investor we start to change our underweight equity position and recommend an equity/bond-split of 55/45. The bond portfolio should contain still a large chunk of government paper and very limited corporate bonds. However, Jumbo-Pfandbriefe might very soon again look attractive compared to governments.
On the equity side we use the DJ Euro Stoxx 50 as benchmark (see table). We made an aggressive shift out of energy back to technology in October. We believe good profits in the energy sector are priced in now whereas technology shares are hit far too strongly by the recent correction. We also overweight financials, which should profit from restructuring, the stable interest environment and tax reform in Germany. The media and utilities weightings have to be seen together. The merger of Vivendi (utilities) and Canal Plus (media) distorts the picture as we have sold the first and bought the last.
Josef Kaesmeier is managing director of Merck Finck Invest in Munich

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