The investment climate has been turbulent to say the least. Over the past few months, the US and European stock markets, have been dominated by developments on the interest-rate and inflation front. The market is keeping a very close eye on every US indicator that might suggest inflation is quickening and it is nervously reacting to any figures that differ from consensus forecasts. Higher wage costs for US companies does not pose a problem in itself if wage rises are adequately offset by productivity gains.
There are indeed signs of a US soft landing, but not all indicators point in the same direction. For instance, domestic demand remains very strong, and consumer confidence is still at record high levels. It is expected that, in the medium term, the dollar will fall in value. Due to the fact that the phase of the business cycle in Europe and the Far East (economic revival) differs to that in the US (decreasing economic growth), many investors will want to pump more capital into Europe and Japan.
The European economy seems to have embarked upon an upswing in growth; the growth figures for the French and Spanish economies have been better than expected. Only the German economic growth figures were slightly disappointing, with the German economy stagnating in the second quarter of 1999, after growing by 0.4% in the first quarter.
Inflation in the euro zone is still under control, and we expect the euro to be strong in the months ahead.
The Japanese economy seems to have embarked upon its long-awaited recovery, with positive growth being recorded in April-June, the second quarter in succession that this has occurred. However, the need for a new incentives package to stimulate the economy is still a matter of concern. Apparently, the economy is not yet in shape to climb out of recession without additional financial help. Furthermore, the strongly appreciated yen is proving to be a hindrance for Japanese exports.
Bonds: Since the beginning of the
year, bond yields have risen considerably, anticipating a recovery in growth and signs of mounting inflation. For the short term (i.e. less than one year), a further increase in both the short- and long-term interest rates has been assumed, and this will depress bond yields. For this reason, we are opting for shorter-term bonds, because their yields are less sensitive to interest rates than those of long-term bonds. For those investing new capital, a wait-and-see attitude should be adopted.
Equities: Fears for a jump in inflation and the accompanying increase in interest rates continue to preoccupy the stock markets. Nevertheless, we believe that the financial markets have already taken the interest-rate hike into account. Moreover, the majority of company results are turning out to be satisfactory, with large industrial concerns, such as Microsoft, Johnson & Johnson and Pfizer, turning in more than respectable performances. Accordingly, we are maintaining our holdings of equities.
Real estate: Despite the fact that interest rates have gone up recently, we are maintaining our real estate holding, with preference still for real estate certificates.
From an equities portfolio geographical point of view, we continue to prefer Europe. When particular consideration is given to valuation, the US stock market currently seems to be less attractive than its European counterparts, with their lower price/earnings ratios. Within Europe, we are continuing to take a small stake in Greece and Ireland. Our holdings in Germany remain slightly overweighted, in view of the cyclical nature of the stock market there. Relatively speaking, the German stock market should benefit more from the economic rally in Europe.
For our sectoral distribution, we are stepping up our holdings of cyclical shares, which benefit relatively more from the favourable economic climate.
We are running down our holdings of financial shares, as they are extremely sensitive to interest rates and will perform less well.
In addition, we remain overweighted in the technology and pharmaceuticals sectors. The pharmaceuticals sector contains quality companies, whilst the outlook for growth in the technology sector (especially the IT sector) remains excellent.
Johan de Ryck is pension funds manager with KBC in Brussels