In balanced portfolios, we are re-ducing our overweighting in equities of recent and moving more neutral. We concentrate on shares where projected earnings have a high degree of certainty and which are considered to be immune to eventual economic weakness. Preferred sectors are pharmaceuticals, chemicals and utilities.
On the fixed income side we are also moving to a neutral position; Japan remains underweighted. Weightings in Euroland portfolios: the 'euro-outs' are overweighted and the duration in dollar-bloc and in Europe is reduced. In emerging markets consideration should be given to taking profits after recent good performance. Although good arguments exist for a weaker dollar vis-a-vis the euro mid-term (eg, balance of payments deficit, portfolio restructuring) confidence in predicting this is low. The yen is also very difficult to forecast (balance of payments surplus and a stabilising economy on the one hand, structural problems on the other). The global economy is now in a weakening phase.
Slower economic growth is expected in both the US and Europe in 1999. A recession in South America, emanating from Brazil, is threatened.
Stabilisation in Asia, however, is now noticeable.
This current weakening phase in the global economic cycle will, most likely, be aggravated by ongoing problems in the emerging markets.The overdue currency devaluation and continuing cash outflows in Brazil are expected to intensify Brazil's recession in the immediate future and won't be without consequences for the rest of South America. The Brazilian crisis is to be viewed differently from the Asia crisis, though, as Brazilian banks appear to be in better financial shape and no comparable speculative bubble was built up.
Signs of problems in China's finance sector have again thrown a spotlight on Asia's tenuous capital markets, Hong Kong in particular. This has resulted in a higher risk premium being assigned to emerging markets investments. While there have been no new shocks to financial markets recently, the situation there remains precarious. A positive trend, however, can be detected in the smaller eastern European countries.
On balance, the outlook continues to be split. On the one hand, while there is noticeable weakening in Europe and probably in the US taking place, the US economy continues to be robust; and stabilisation in Japan could be in the offing. On the other hand, there are ongoing problems in the world's threshold economies with potential for new crises to break out there at any time. In the US, economic growth continues to be strong but is expected to come in noticeably lower in the first half of 1999. Further cuts in interest rates, barring any new shocks in the finance system, are not likely. At the same time an interest rate hike is also not on the cards. A 'soft landing' in the US economy appears to be the probable scenario.
In Euroland, as a result of lower exports, there has been a conspicuous loss of dynamism in the economy. Industrial production is regularly showing signs of slowing. In contrast to the US, however, consumer spending is showing steady signs of im-provement and can be expected to be a significant source of support throughout 1999. The view on Japan is contradictory. Economic activity is still very sluggish. As a consequence of the deep recession in 1998, economic recovery in 1999 can hardly be reckoned with. Against this, there are signs that Japan's structural problems are finally being addressed.
Earnings are still increasing, albeit at a slower rate; interest rates are, and for the near future are expected to re-main, low; the long-term growth trend is still very much intact; and risks are continuously being discounted in market prices. While a good element of risk in the markets must be acknowledged, the chances of a sharp correction seem small.
We anticipate a sidewards trend in the markets over the next few months, top in the Euro Stoxx 50 = 3500; top in the DAX = 5200. Mid-term earnings development will determine stock price levels. In general earnings should have a steadying influence, although there will be noticeable differences between various sectors.
We continue to expect no dramatic developments in bond markets. No further steps regarding interest rates are anticipated, either in Europe or in the US. Nonetheless, risk to bond markets is increasing (especially in Japan).
Factors contributing to this are a potential turnaround in commodity prices and a trend to demand-side policies in Europe.
Ernst-Ludwig Drayss is managing director and chief investment officer of Deutsche Asset Management in Frankfurt.