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investment outlook

April / May 2014 Monthly newsletter


Tensions still local Despite the agreement between the West, Russia and Ukraine, it remains to be seen whether calm will be restored. Tensions are high but still local, with no immediate threat of contagion to global financial markets. Meanwhile, the signs of global economic recovery are growing stronger now that the severe winter in the United States has ended and Europe is shrugging off the last remnants of recession. Market environment> page 2

Low inflation, no real deflation After fifteen years, the Japanese authorities have finally left deflation behind, but inflation in the United States and Europe has fallen to a worrying level. However, we do not foresee the emergence of actual deflation in either region. The recovery of economic growth will reduce the underutilisation of production capacity, first in the United States with Europe likely to follow in 2015.

Special> page 4

Small shift in property emphasis In the past month we made no changes to our equity and bond allocation, so we remain moderately overweight in equities and strongly underweight in bonds. Meanwhile, despite the expected increase in financing costs, we have raised the property weighting in the defensive risk-return profiles that include property. Defensive investors usually need the fixed flow of income that is generated by property investments. Outlook> page 5

market environment The global financial markets remain unsettled due to the conflict between the West and Russia over Ukraine. The accord reached in Geneva on 17 April was a step in the right direction, but whether the OSCE can contain the forces that have been unleashed remains uncertain. In addition, new heavier sanctions on Russia could push its economy into a financial crisis. In the meantime, the global economy is gathering momentum – driven by the western countries – now that spring has begun in the United States and the European countries are finally starting to grow. At the same time, the dovish tone of central banks suggests that interest rates will remain low for a relatively long time.

sales tax hike from 5% to 8% effective from 1 April. Any signals that this increase is impeding economic growth will undoubtedly prompt the Bank of Japan to take additional measures on top of the large-scale stimulus package that is already being rolled out. The willingness of the central banks to continue their accommodating policies supports the mediumterm outlook for the financial markets.

Favourable global economy From December 2013 to February 2014, the United States suffered a sustained spell of extreme winter weather, with the construction and transport sectors particularly hard hit. This put a strong brake on economic growth in the first quarter, but since March, most indicators have been pointing to accelerating growth and an improving labour market. Fuelled in part by pent-up demand, growth in the second quarter will presumably be much stronger, possibly rising by as much as 4.5%. The eurozone economy is gradually perking up, though the threat

Economic growth (estimates) in selected countries

of deflation appears to suggest the opposite (see Special on page 4). This apparent threat is largely attributable to deflatio%

nary developments in the southern member states. However, the economy is gaining traction there, too, and these forces will


gradually disappear. In general, economic growth in the emer-


ging markets is still strong, but is not accelerating. In the first


quarter, the Chinese economy even slowed slightly to 7.4%


from 7.7% in the fourth quarter of 2013. However, the decele-


ration is mainly on the production side of the economy, while


spending continues to show strong growth.


Central banks remain in stimulus mode Recently, many central banks have struck a rather dovish tone. This applies in particular to the US Federal Reserve (Fed), where the new chairwoman – Janet Yellen – has abandoned the unemployment threshold for raising the fed funds rate in favour

1 0 -1

United States

Eurozone 2015

United Kingdom 2014

Japan 2013

Emerging Markets



of a broader set of variables. As a result, an interest rate hike is not to be expected until mid-2015. In the eurozone, the ECB

Source: ABN AMRO Group Economics

continues to fear deflation, partly because the strong euro is dampening the prices of imported goods. Though we do not

The United States and Europe will see strong growth accele-

consider deflation very likely, ECB interest rates are expected

ration relative to 2013. Growth in the emerging countries,

to remain at their current low level until well into 2015. In Japan,

including China, remains high

the central bank is keeping a close eye on the impact of the

page 2

market developments The financial markets remained unsettled in April. The conflict between Russia and the West over Ukraine has made many investors more risk averse. This renewed risk aversion was reinforced by downbeat reports about the Chinese economy, which made investors doubt the brightening prospects of the global economy as a whole. This caused most equity markets to dip over the past six weeks to end-2013 levels. Investors thus fled once again from equities to the perceived safety of bond markets, where prices rose and bond yields fell.

outlook for corporate bond yields has also decreased. Nevertheless, we still expect these bonds to yield total returns of between 0.5% and 1% for the second quarter of this year, as opposed to a return of 0% on German 10-year government bonds for the same period. The latter is due to our expectation that interest rates on government bonds in the United States and the European core countries will rise gradually if the economy accelerates further and investors steadily regain their risk appetite.

Latin America and emerging Asia regain some ground The risk aversion was particularly visible in the technology sector, although a distinction should be made between the established tech firms and newcomers. Share prices of established companies such as Apple, Microsoft and IBM remained resilient in recent months, whereas newcomers such as Facebook and Twitter took a battering. Corporate results for the last quarter of 2013 varied strongly in quality, with US companies tending to slightly outperform their European peers. One striking regional development was that emerging markets – except Eastern Europe – recovered somewhat in the first quarter from a series of lacklustre years, when their prices

European 10-year government bond yields

lagged far behind those of the United States, Europe and Japan. The Latin American markets performed particularly strongly, yielding a return of about 8.5%. Among the leading markets, Japan has posted the biggest loss since the start of this year, down 11.5%. If there is no further escalation of the



Ukraine conflict, investors are expected to shake off their risk


aversion. The global economy is picking up, starting in the


United States, with Europe likely to follow with some delay. Companies are well-positioned to take advantage of this


upturn, now that their profit margins are at reasonable levels


thanks to implemented cost reductions.


Bond markets expensive following renewed price gains The increased risk aversion has driven investors back to the bond markets, causing the yield on 10-year US Treasuries to fall

2 1


2009 Italy

2010 France






to 2.65% on 17 April, compared to 3% at year-end 2013. Yields in Germany (from 1.94% to 1.49%), France (from 2.57% to

Source: Datastream

1.96%) and Italy (from 4.1% to 3.16%) declined even more sharply than in the US. The search for yield also gave a strong

The 10-year interest rate has fallen more strongly in many

impulse to demand for corporate bonds in the first quarter,

European countries than in the United States. Italy, in particular,

leading to a further narrowing of the yield differentials between

saw a sharp fall despite political unrest and a new government

corporate and government bonds. As a result, the short-term

under Matteo Renzi

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special Deflation... or inflation?

Limited upward pressure on European interest rates

Despite extremely expansive central bank policies, inflation has

In the United States, rising inflation – together with diminishing

been slowing in the United States and the eurozone since 2011.

demand for bonds from the Fed – will push capital market rates

It would therefore seem that the traditional reasoning that

higher. Added to this, the Fed will come under mounting

expansive monetary policy leads to a sharp increase in inflation

pressure to raise its own rates faster and further. In the

no longer holds true. In the eurozone, there are even fears of

eurozone, interest rates will rise to a much more limited

deflation, particularly if its currency continues to strengthen.

extent and are therefore set to remain extremely low for an

President Draghi of the European Central Bank (ECB) has

extended period. The widening interest rate differential with

already signalled that he will not shy away from unconventional

the United States will strengthen the dollar versus the euro.

measures if the euro rises above $1.42 (now $1.38). The low

This makes deflation less likely, and means unconventional

inflation rate and the threat of deflation mean that the current

measures will not be necessary.

situation is entirely different from 2008/09, when falling price levels were fully attributable to the extremely strong decline in energy prices. Now, decreasing nominal and real wages combined with weak spending are responsible for the strong downward price pressure. Though there is still no question of real deflation, the low average inflation rate means that certain goods and services are clearly falling in price. Deflation is an insidious economic phenomenon where falling prices push spending and production into a downward spiral. So what is the outlook for inflation in the coming period and what are the

Inflation in the eurozone 2007 - 2014

implications for interest rates?

Difference in pace between the United States and the eurozone For the past year, inflation in the United States has been fluctuating between 1% and 1.5%. And after several months of extreme winter weather, the economy has been picking up since March. This is also translating into a higher utilisation of the production capacity. In March, consumer prices advanced 1.4% compared to March 2013. Given that prices fell 0.4% in April 2013, an increase of 0.2% in April 2014 (a reasonably normal pace) would lift the year-on-year increase to 2%. In the eurozone, prices shed a mere 0.1% in April 2013; a 0.2% increase in April 2014 would raise inflation from 0.5% in March to 0.8% in April, still well below the ECB target of 2%.

% versus 12 months earlier

5 4 3 2 1 0 -1





Total inflation





Total inflation, excl. food and energy

Nevertheless, a further rise over the course of this year is on the cards for the eurozone. There was a particularly sharp decline in prices in July 2013 (-0.5% compared to June), so that

Source: Datastream

a small increase this year could give inflation a somewhat stronger upward impulse. Meanwhile, the eurozone economy

Inflation in the eurozone has dropped to 0.5%, prompting the

is beginning to show very considerable growth, which will

ECB to consider unconventionel measures to bring inflation

weaken the deflationary forces in the southern member states.

closer to 2%. We expect inflation to rise again during 2015 as

All in all, however, inflation in the eurozone will remain on the

accelerating economic growth will cause an increase in the

low side for the time being.

utilisation of production capacity

page 4


Europe remains favourite for equities

positive total returns. The higher risk of this latter category is

Low inflation, ample liquidity, improving profitability and attrac-

acceptable, as the improving economic environment has

tive valuation levels constitute the driving forces behind the

reduced the default risk.

equity markets for the medium term. This explains our current overweight position in equities. Our favourite region remains

Commodities and property

Europe, which is better positioned for a cyclical recovery than

We also continue our neutral stance on commodities. Within

the United States and offers more attractive valuations. In

this asset class, we are overweight in basic metals and under-

addition, we maintain a limited overweight position in Japan,

weight in gold and oil. We maintain a neutral opinion on

which can benefit from the accommodating macroeconomic

property for most risk-return profiles. Property will suffer from

policy and improved competitiveness due to the weakened

rising interest rates, but benefit from a reviving global eco-

yen. We maintain our neutral stance on emerging markets, as

nomy. In the more defensive profiles that include property, we

well as the underweight in US equities, where valuation levels

are raising the weight of property at the expense of cash. After

are somewhat less attractive. No changes were made to our

all, investors will benefit more from investments that genuinely

sector preferences. Our favourite sectors are still information

generate greater income, despite the expected higher finan-

technology, materials and health care, while we remain under-

cing costs.

weight in utilities, telecom and consumer staples.

Attractive returns in the bond markets are thin on the ground The decline in capital market rates, which took place in the first quarter of this year, has once again made bonds expensive. The anticipated increase in government bond yields in both the United States and Europe will put the prices of these bonds under pressure. As we also foresee a slight rise in corporate bond yields in the various risk segments of this market, we are maintaining the strong underweight in this asset class as a whole. We remain strongly underweight in government bonds. In this segment we have a preference for Spanish and Italian bonds. After selling our entire position in emerging market debt earlier this year, we are overweight in corporate bonds. We expect this position, which consists partly of investment-grade bonds and partly of high-yield bonds, to generate limited

page 5

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Beleggingsvisie april mei eng 2014