- Strong growth of the global economy supports upward trend of equities
- Inflation remains low. Core inflation below the ECB target of 2%
- No correction of bond market in sight, but generally slight increase in yields
- Focus on equity funds as well as mixed and bond funds with higher degree of risk
2017 is drawing to an end, and the bottom line is positive. “The outcome is significantly better than we had expected. Since the financial crisis in 2008, the global economy has never expanded more quickly and especially concertedly than in 2017. Also, inflation has surprised on the downside, falling short yet again of the expectations held by central banks and analysts,” summarises Heinz Bednar, CEO of Erste Asset Management (Erste AM). It comes with little surprise, then, that equity funds and bond funds with higher degrees of risk have earned positive yields for investors. Technology shares and shares from the emerging markets recorded the biggest gains at +20% (source: Erste AM as of 23 November 2017). The Austrian equity market put in a strong performance as well in 2017 and benefited from the renaissance of the interest in Eastern Europe. The only fly in the ointment from the euro investor’s point of view: their gains have been slightly eroded by the weakness of the US dollar.
Strong economy favours equities and riskier bond segments
Erste AM Chief Investment Officer, Gerold Permoser, is reminded of 1999 by the strong economy, coupled with the ambitious valuations: “The rest is history.” But he does not see any form of hangover sentiment on the financial markets: “We expect the economy to continue growing strongly and broadly in 2018.” In the USA, tax breaks could boost the already great performance of the economy further, and in Europe, the economic upswing has become so broadly-based that even the weaker countries in the peripheral states are benefiting. In the emerging markets, too, the problem-laden countries of recent years such as Brazil and Russia seem to have overcome their recession and are picking up momentum again. “A phase of strong economic activity makes a case for holding risky assets in the portfolio,” says Permoser.
US economy caught in the longest phase of expansion in its history
The US economy is currently experiencing the longest phase of expansion in its history (N.B. US records started in 1850) and is clearly ahead of Europe, which has to be seen with caution, as Permoser warns. “Long periods of expansion usually lead to imbalances building in the economy and/or the financial system.” They emerged for example in 2008 on the US property market or in 2000 when the dotcom bubble burst. At the moment, there are no signs suggesting the existence of such imbalances in the US economy
Changes in the interest rate policy of the central banks as main risk
Thus, the US central bank and its policy of tightening interest rates slowly but surely remain the main risk for the economy. Excessive interest rates have often been the reason for the US economy (and others) to fall into recession like at the beginning of the 1980s, for example.
Inflation remains moderate
The experts of Erste AM are acutely interested in the further development of inflation. In 2017, inflation remained yet again below expectations both in the USA and in Europe. In view of the good level of growth, one can therefore expect unutilised capacities to become increasingly scarce. In the USA, the unemployment rate is currently 4.1%, i.e. at the lows of recent decades. The same is true for the OECD region overall. From an economic point of view, the risk remains that inflation might not only rise in 2018, but actually do so by a surprising extent, as Permoser points out. This would force central banks, especially the US central bank, to tighten their interest rates more than currently anticipated by the market.
Additional supply of US Treasuries will cause moderate yield increase
The US central bank has started this year to let the Treasury bonds acquired within the Treasury bond purchase programme expire. This means that these bonds will not be reinvested up to a certain volume. Overall, a total of USD 229bn worth of additional Treasury bonds should therefore enter the market. “We expect this additional supply to exert a slight upward pressure on Treasury bond yields in 2018. In total, the European and the Japanese central bank will still be buying more government bonds in 2018 than will be issued net in the USA, Europe, and Japan together,” explains Permoser.
Good opportunities for investors
“We are starting optimistically into 2018 and continue to see good opportunities for our investors,” as CEO Heinz Bednar sums it up. But one has to keep an eye on the risks, such as an unexpectedly strong jump of inflation. One must also not underestimate the impact of certain political developments on the markets. For example, any escalation of the rocket launches by North Korea could vex the markets.
As of 31 October 2017, Erste Asset Management manages assets worth EUR 61.2bn, which represents an increase of 5.9% relative to the end of 2016. Bednar is optimistic that assets under management will rise by a similar percentage in 2018. Erste Asset Management is especially happy about the development in Austria and the Czech Republic.
Active management of asset classes particularly important in 2018
Even though all signs currently suggest a positive 2018, volatility might rise next year. This requires investment solutions that can flexibly adjust to the respective status quo on the market. Mixed investment solutions with flexible weightings of the various asset classes have the upper hand in this scenario. Slightly more aggressive mixed funds that also permit a higher equity portion are interesting in this context. In addition, technology shares and emerging markets bonds denominated in local currency remain attractive as niche investments.
Gerold Permoser, CIO & Heinz Bednar, CEO
Gerold Permoser, CIO & Heinz Bednar, CEO
Gerold Permoser, CIO
Heinz Bednar, CEO
Conservatory, Erste Campus
Pictures: Photographer Daniel Hinterramskogler
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