Our portfolio strategy is basically neutral. The economic landscape is rather fuzzy: we expected Europe to catch up with and even replace the US as the ‘global growth engine’ in 1999. Nevertheless, the US economy is likely to outperform Europe once again this year, mainly due to the robustness of its service sector. Even manufacturing, severely punished by global emerging markets weakness, seems to be picking up.
And what about Europe? Soon after Emu, important imbalances in terms of inflation and growth are beginning to show up. Spain and France are growing 0.5 to 1.5% faster than Germany or Italy. At the same time inflation spreads have widened above 1%. How long can these differentials last? To make things worse, commodity prices are beginning to build up and even OPEC seems to have reached a sustainable agreement on production quotas. Is it the end of the ‘deflation era’?
Do we believe then in the economic cycle rebound anticipated by the market (cyclical sector outperfomance and yield curve steepening) or in the economic reality of the world ex US? It is difficult to foresee; that’s why we would rather adopt a neutral position in our portfolio equity allocation.
On fixed income the first quarter of 1999 has been characterised by an increase in interest rate volatility; even though our portfolios show longer duration than our benchmark (5.5 years), we have slightly shortened it taking into account such risk. The imbalances within the EMU mentioned above, and a more favourable outlook for monetary policy than the one already discounted by the market, have encouraged us to increase our US bond position. At the same time, the sharp rebound in global commodity prices has led us to add to our emerging markets credit risk, so we can take advantage of some credit spread tightening as well as a (possible) inflation hedge. We have hedged 60% of our dollar position due to the impressive strength of the US currency.
At the same time the beginning of 1999 has been quite volatile across the equity markets. Obscured by such volatility, we note strongly divergent sector and stock perfomance; we believe this trend will persist, its main supportive factors being,
q Directional risks of the yield curve
q Overly optimistic forecasted earnings
q Global corporate concentration processes
On equities we remain bullish on a long-term basis. The expanding liquidity bubble promoted by the central bankers’ easy stance is spreading through the individual and corporate sectors, enhancing the migration from low risk/return assets towards equity investments. At the same time an increasing emphasis on shareholders’ returns has spread from the US to the rest of the world (even Japan is experiencing it) encouraging buybacks, restructuring and business concentration.
We feel it is not the right time to increase our equity position. We are cautious on equity valuations. We are especially aware of valuations in the US and have recently sold our internet exposure due to dismaying valuations. We favour continental Europe instead and hold a neutral stance in Japan. Germany, Italy and Spain fell behind in the first quarter and are especially attractive on valuation grounds according to our analysis.
Uncertainties surrounding the US market have undermined the ratio of advancing to declining stocks. Therefore we have indexed our portfolios further. We maintain a neutral stance in the Japanese stock market. Japan is experiencing a major cultural change. But the worst is yet to come in the consumer and capex areas and it seems too soon to take an overweight position. These fears reinforce our defensive Japanese sector allocation focused mainly on pharmaceutical and communication stocks.
European stocks are going through a significant concentration process in a liquidity-driven market. Germany, Italy and Spain offer in our view the best value now. On a sector basis we favour utilities, telcos and real estate stocks, and we hold an underweight position in banks and basic industry.
Enrique Román is chief investment manager and Nicolás Barquero is investment manager at BBV Pensiones in Madrid