Bank Austria has a long-term, strategic allocation, which stands at 3% cash, 57% bonds and 40% equities. Our current allocation matches the strategic one exactly, as can be seen from the charts.
While the first quarter of 2003 was decisively dominated by geopolitical topics, such as the war in Iraq, a surprisingly swift resolution to the crisis has brought the market’s attention back to the fundamental data. In the US, first quarter earnings came in surprisingly strong and beat expectations by a relatively wide margin. Whereas the consensus of analysts had looked for earnings growth in the magnitude of 8% during Q1, actual numbers tallied at closer to 12%.
Economic data have been somewhat less sanguine, however. In the US, the Federal Reserve seems to be worried about deflation and thus stands ready to lower interest rates even further. The fact that US producer prices fell by no less than 1.9 % in April certainly stoked deflationary fears in the market. All of this led to a strong rally in bond prices, with yields falling to 45-year lows. Obviously the bond market is much less convinced than the equity market that an economic upswing is imminent. A rate hike is also only a very distant prospect on the horizon, so there is very little to hinder bond performance at the moment.
In Europe, a ‘flash’ estimate of growth in the first quarter showed stagnation, ie, growth of exactly 0%. Germany seems to be in an economic slump, with tax revenues falling well short of expectations and the country again missing the Maastricht deadline of a 3% deficit. A powerful rally in the euro has done nothing to ease those pressures. While US exporters are feeling the tailwinds of a weaker dollar and are therefore surprising on the upside, a number of European companies have already warned that the strong euro will hurt their results.
With first quarter results in the US exceeding expectations, but economic data on both sides of the Atlantic not really signalling an undisputed recovery, we have opted to maintain our neutral equity exposure of 40%. Within the equity portion of our portfolio, we have recently increased our exposure to Euroland to 18%, versus a 13.6 % benchmark weighting of the MSCI World Index. We continue to believe that the euro will not suffer any decisive near-term setbacks, which is why we have boosted our stake in Euroland equities. We have also increased our weighting in Japan, to 12% versus 7.8% benchmark. We view this year’s sell-off in Japanese equities as excessive and think that an anti-cyclical stance might be rewarded. These moves came at the expense of US equities, which we reduced from formerly 56% to 51%. The benchmark weighting stands at just over 57%. The rationale behind this move has largely to do with currency considerations. Our exposure to UK equities is slightly underweight, at 9% versus 11.2% benchmark. European countries outside the Euro-zone, that is mainly Switzerland and Sweden, remain underweight at 3%, versus 4.7% benchmark. We still favour the emerging markets and hold a 7% exposure there, versus 5.6 % benchmark. We think that the emerging markets especially will profit from an economic upswing.
In terms of sectors, we are somewhat sceptical of the run-up in technology shares this year. Demand seems to stem mostly from replacement of outdated equipment, a lasting turnaround in tech orders still looks rather elusive. We think that US exporters which benefit from the weak dollar could be a good bet. For investors wishing to take an anti-cyclical approach, we think that oil shares could be worth a second glance. Oil companies showed exceptionally strong numbers in Q1, whereas their shares could not match those gains.
As for our bond allocation, our benchmark is a synthetic one, consisting of 50% JP Morgan Government Bond Index and of 50% Euroland Effas Bond Index. Through this approach we have boosted the Euroland portion in the benchmark to gear the allocation more towards our home currency. Our bond allocation is heavily weighted towards Euroland, which accounts for 92% of the total, versus 68.7 % benchmark. Again, this is an expression of our belief in a continued show of strength in the single currency. UK bonds comprise 3% of the bond allocation, versus 2.5 % benchmark, and European bonds from outside the Euro-zone make up 5%, versus 1% benchmark.
Monika Rosen is head of research in asset management at Bank Austria in Vienna