Equities generally lacked direction in March. Improving economic conditions in the US and the eurozone supported investor sentiment, but rising geopolitical tensions and a hawkish Fed acted as drags. US bond yields rose, but low inflation held yields down in the eurozone. We are positively exposed to market risk, although we closed our overweight in European equities and our short euro position. We rotated our overweight in US real estate into European real estate.
Tensions between Russia and Ukraine influenced markets. How did you react?
When the tensions arose, we developed different scenarios and analysed which of our positions were most vulnerable. We concluded these were our overweight in European equities versus US equities and our short duration in German Bunds. As the crisis developed, we closed our overweight in European equities versus US equities. We still believe there are fundamentally positive factors supporting this trade such as an improving economic outlook in the eurozone, favourable monetary policy, attractive valuations and the prospect of strong company earnings growth.
The Fed has a new chair and there have been some dovish comments from European monetary policy makers. Is central bank policy still positive for equities?
In March, the Fed’s Federal Open Market Committee (FOMC) policy meeting, the first led by Janet Yellen, produced an unsurprising media statement. The Fed continued tapering its asset purchases by USD 10 billion per policy meeting as it felt the recent economic slowdown was mainly due to adverse weather. At this pace, the Fed should have wound down quantitative easing (QE) by October or December. It ditched its 6.5% unemployment rate threshold in favour of a broad range of indicators as monetary policy guidelines. In this regard, it is back to normal for the Fed. But at the subsequent news conference, Janet Yellen said the time between the end of QE and the start of rate hikes could be as short as six months. She stressed the labour market was weak, but improving. FOMC members expected rate hikes to come sooner and faster than previously thought. This drove up bond yields, but we think it is too soon to see monetary policy as a headwind for equities. Yellen sounded more dovish in a speech at the end of March.
After its early March policy meeting, it seemed the ECB was done with easing. Several indicators pointed to improving growth. For example, the Economic Sentiment Index rose in March to its highest since 2011. Portugal, Italy and Spain are leading in terms of annual improvements. In Q4 2013, employment rose for a second consecutive quarter for the first time since 2008. Overall, the gains were marginal, inflation was very low and the euro was on its way to 1.40 USD. So when Bundesbank president Weidmann and the head of the Finnish central bank Liikanen discussed additional monetary easing, such as a negative rate for banks depositing excess reserves at the ECB and even QE, their primary goal appeared to be to talk down the euro. It worked: the euro depreciated. The ECB has opened the door to more policy action, although we do not think it will go as far as QE. At its early April meeting, the ECB left its policy unchanged. All in all, we see monetary policy as positive for global equities.
Have you changed your asset allocation?
We remain positively exposed to risk. We are overweight global equities, European high-yield bonds and European real estate and short duration in German Bunds. In a broad sense, economic conditions are improving in the US and Europe, inflation is low and monetary policy extremely stimulative. Valuations are stretched for US equities and European corporate bonds, but we do not expect this to drive markets in the short term. We de-risked our model portfolio by closing our overweight in emerging market debt in February and in European equities in March. We closed our short euro position since this was moving against us. We rotated our overweight in US real estate into European real estate where we expect fundamentals to start improving.