For 2001 we expect a decline in global economic growth triggered by the US economic slowdown. According to our estimates, US economic activity will increase 2% on an annual basis. Hence, with an annual economic growth of approximately 2.6%, Europe should overtake the US in economic terms for the first time since the early 1990s. In contrast, Japan will remain on the brink of recession, with an estimated annual growth rate of just 0.9%.
Although the global economic picture has weakened, the worst should be over soon. Stimulated by further Fed rate cut(s), down to a level of 4%, the global economic turning point will be achieved in the second half of the year. In Europe, the loss of growth momentum this year will be less severe, as tax cuts help to offset the drag from external growth. Hence, with Euroland inflation running well above the European Central Bank’s 2% target, we expect only another modest rate cut to a level of 4.25% by the end of July.
On the foreign exchange side, the fundamentals point to a euro appreciation – the growth differential is positively skewed towards Euroland and the interest rate level is higher in Euroland – just to name two major arguments in favour of the euro. Nevertheless, the euro remains reluctant to leave its trading range. In our opinion, the major problem for the euro is a lack of confidence in the ECB, while doubts persists whether Europe constitutes an optimal currency area.
However, with the physical introduction of the euro in January 2002 confidence should increase and we expect a moderate but continuous appreciation of the euro versus the US dollar with a year-end target of slightly above e0.95 = $1. Regarding the third major currency, the yen will gain versus the euro in the short term, but on a longer term perspective, Japan’s ongoing recession and new monetary policy will maintain the pressure on the yen.
It follows from our global economic expectations that we favour equities over bonds in a global portfolio during the second half of 2001. In our view, consensus earnings in Europe are more realistic than in other markets, such as the US, and Europe’s earnings momentum seems stronger as well. In addition, in terms of valuations, European equity markets look more attractive relative to the US.
However, there are strong signs that some of the key sectors in the US market, such as the semiconductor industry, will bottom out in the coming weeks. Moreover, the rising liquidity will support the broad market considerably, despite the still weak earnings momentum. Therefore, an increased exposure to the US equity market is basically just a matter of the right market timing.
Hence, in the developed equity markets, Europe remains overweight compared to its benchmark, while the weightings of both the US and the Pacific Rim have been increased recently from underweight to neutral with a bias for further buying of US equities.
In the short term, the Pacific Rim should be able to take advantage from the expected recovery in the US equity market, although there will be virtually no stimulus from the Asian economy itself.
Concerning the bond segment of our global portfolio, we expect an increase in the yield of the US 30-year bond up to a level of 6% as consequence of stronger economic activity in the US and a recovery of the equity markets. In Europe, we expect the yield curve to steepen and therefore continue to favour a bullet strategy. Higher long-term yields are also expected in the Japanese market pressured by the zero interest rate policy as well as the still huge debt refinancing needs. However, global government bonds remain underweight compared to their benchmark in favour of the persistently growing European market for corporate and high yield bonds.
Current swap spread levels of 41 basis points appear expensive and we think that spreads will widen again. This will result in an underperformance of swap-correlated products like Pfandbriefe. However, due to the ongoing decrease in risk aversion, we think products that are less swap-correlated, like corporate bonds within the A and BBB range, will outperform government bonds. We also hold an overweight position in the high yield sector, which is still recovering from the telecom industry problems that surfaced throughout the world earlier this year. Global Portfolio as of April 30th, 2001
Ingrid Szeiler is head of global asset allocation at Raiffeisen KAG in Vienna