China has once again taken center stage in early 2016 as its government's currency management raised uncertainty about the future path and degree of RMB depreciation among global investors. While the risk of global contagion has risen, our base case remains for China avoiding an economic "hard landing". More importantly, we expect continued growth in the US and Eurozone, balancing the general growth weakness of emerging markets (EM). The US Fed kicked off the rate hiking cycle on December 16th. This happens against the backdrop of a robust labor market, as highlighted by strong new job creation in December. Still, this hiking cycle will progress only very gradually due to low inflation and the prevalent weakness in parts of the economy, namely manufacturing. Meanwhile, Eurozone growth continues apace. Latest leading indicators showed a further mild improvement in the outlook. Still, at persistently low inflation levels more ECB easing is becoming more likely.
Against a backdrop of volatile markets susceptible to otherwise manageable negative shocks as well as the uncertainty over the Chinese government's currency management intentions, we recommend a neutral position in global equities in our tactical asset allocation. However, we believe Eurozone companies are currently best positioned to benefit from continued global demand. Low refinancing costs and a supportive currency effect should additionally support rising profitability. Therefore, we prefer Eurozone over UK and EM equities in a regional context. UK equities have a large exposure to the energy and the materials sectors, where the latest rout in commodity prices weighs, while EM equities earnings and profit margins continue to deteriorate against a backdrop of weak domestic fundamentals.
We maintain an overweight in euro high yield (HY) bonds. The asset class held up relatively well so far this year, despite the market turmoil. At an average yield to maturity of 6.4% euro HY bonds offer an appealing yield pickup over "safer" bonds. At the same time, the credit quality of euro HY is relatively good, with 64% of the index rated BB. The euro HY index has a relatively small exposure to the energy sector of around 6%, and default rates are expected to remain below 2% through 2016. From current low yield levels, high grade bonds are unlikely to deliver attractive total returns over the next 6 months. We are underweight the asset class. But high grade bonds continue to play a crucial role as portfolio diversifier, stabilizing portfolio returns when risk assets sell off.
We maintain our overweight position in the Norwegian krone against the euro. A stabilizing Norwegian economy should lead to monetary policy divergence and support a rising yield differential in favor of the krone. We are adding an underweight position in the Japanese yen against the US dollar. The yen strengthened amid the recent global risk off sentiment, thereby making it even more difficult for the Bank of Japan to reach its inflation target. The BoJ is hence expected to at least maintain, if not expand, its very easy monetary policy stance. The US Fed, on the other hand, has embarked on a path of gradual policy tightening. For EURUSD, we maintain our 6-month and 12-month forecasts of 1.08 and 1.10, respectively.
Alternative investments and precious metals & commodities
For the third year running, we maintain a zero allocation to commodities as an asset class in our asset allocations. Global commodity markets remained a major source of volatility and concern into 2016. Oil prices fell below USD 30/barrel – the lowest level since 2003. Base metals also suffered from continued weakness in emerging market growth. Gold benefitted somewhat from the worsening in risk sentiment, and we expect the gold price to stabilize around current levels. Contrary to commodities, hedge funds, as well as private market investments, offer attractive sources of alternative risk and return drivers, and should be considered by any investor who can tolerate limited liquidity.
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