What is your outlook for the eurozone?
First of all, I think it’s extremely important that the sparring between politicians and the European Central Bank (ECB) has turned quite positive. That was not the case in the past three years. They made many mistakes in how to deal with the situation and how to communicate. This has improved a lot.
And the steps that they have taken during the past few months have helped calm fears and shrink tail risks. In particular the very important speech by Mario Draghi [the president of the ECB], in which he made a strong call about the irreversibility of the euro, was a game changer.
So the question whether the ESM [European Stability Mechanism] is sizeable enough to cover both Spain and Italy, when needed, is not critical anymore. If preconditions are met and the peripheral countries accept the Troika plan, the ECB will ultimately fill the gap.
We also feel that there’s some kind of hidden support for the ECB strategy, especially from Germany.
In public forums, you see that German Chancellor [Angela] Merkel and [Jens] Weidmann, the president of the Deutsche Bundesbank, showed reluctance towards the ECB strategy. But they know that there was and is no alter-native. Behind the scenes, they gave their support to Draghi and the other ECB members. It’s important from a psychological standpoint that those in power are seen to be able to calm inflation fears among the general population, particularly in Germany, after very bad experiences in the past.
What does that mean for investors?
Now that the tail risks have faded visibly and macroeconomics are stabilising, we’re much more convinced that investor sentiment will improve and buying interest will emerge for more risky assets, and in particular for equities, on a more sustainable basis.
Having said that, we are not on a linear growth path.
We have so many risks still hovering around — ranging from macroeconomics to geopolitical to execution risks in the eurozone. During the next few months, if not years, we will continue to be confronted with volatility and visible setbacks in the equity space. But the trend is up, showing a mean reversion pattern back to fair value. In particular, for the next few months, there is still room for upside given ample liquidity supply, a lack of attractive investment alternatives, and the fact that many investors have not participated in the stock market rally so far this year.
Which asset classes do you like the best?
We are seeing fund flows switching out of nominal assets to real assets.
This makes for a pretty obvious call to underweight cash and global core bond markets, meaning the nominal space, and to overweight the real asset space. Real assets include private equity, infrastructure, real estate, equities and commodities, especially gold.
So we have different investment opportunities across different asset classes.
We think the combination of de-escalation in the eurozone, not stellar but reasonable global growth, a pick-up in investor sentiment, favourable valuation and a lack of attractive investment alternatives, are five strong reasons supporting our constructive view. And probably the strongest push factor is the liquidity supply from central banks. Economic growth and corporate earnings will not be the drivers of the markets in the short to medium term, so multiple expansion in a sense of increasing price to earnings ratios is our scenario for 2013.
Conversely, which asset classes do you like the least?
Cash is not a value-adding asset class; it’s just a kind of flexible, tactical holding. Do you really want to invest in cash with zero yield, or global core bond markets, such as Treasuries (1.7%) or German bunds (1.5%) and so on? That’s anything but a rational investment strategy. When you add inflation to the picture, cash-equivalent assets often end up in negative real yield territory, and therefore in real terms they don’t even manage to preserve capital. The negative yield is definitely a case against cash and against global core bond markets. From a diversification point of view, of course, they should be part of a broad diversified portfolio, but they should be underweight and short duration.
Within equities, we prefer some emerging markets and European equities. Eurozone equities, in particular, are a buying opportunity with further room for upside.
These markets had been oversold. They are now coming back to more normal levels, but still far away from their historic highs. The eurozone markets have already started outperforming, and this will be sustainable outperformance in my view.
In some Asian markets (for example, China) we are waiting for a turnaround. We see support from the People’s Bank of China strategy given inflation is coming down.
After a long period of underperformance, China’s equity markets will turn the corner in the next few months especially when political uncertainties dissipate. We are also positive on Korea and Thailand, but stay cautious on India and Indonesia.
On the other hand we are not so positive on US equities from a relative valuation standpoint. Recovery prospects and corporate earnings strength have already been priced in. So we are underweight US equities and overweight select Asia and European equities.
How would you rank your preferences?
Equities is number one on my list. I would rank gold second because central bank policies are a clear driver for further gold price appreciation. We also see a change in correlation — in the past, you would have rising equity markets and falling gold prices, or vice versa.
But this time we expect a positive correlation. We expect equity prices to appreciate a further 5% to 10% plus, with gold prices rising at a similar rate over a period of three to six months.
Gold is not a safe haven investment, but rather it is central banks’ behaviour that drives the price momentum.
Everyone talks about gold, but when you look at their allocations, gold often represents a small percentage and there is room to add more.
Number three on my list is high-yield bonds and emerging market bonds. In a world where you are confronted with the lowest yields ever, I think it is and stays definitely value-adding to have some exposure in high-yield or emerging markets bonds. The carry is attractive and there is still potential for further spread tightening.
So all in, you aren’t negative about the global investment environment?
No. For me, it’s a clear positive that we are still climbing a wall of worry. We are far away from euphoria and that’s healthy.
When we look back, trading volume was thin during the rallies in January, February, June, July and August this year. A lot of money has been sitting on the sidelines. The majority of investors are still underweight real assets, risky assets and equities. They missed the rallies so far.
The closer the year-end gets, the bigger the performance pressure will be on institutional investors.
Maybe some market participants will now be forced to step back into the markets. An uptick in buying interest can translate into increasing demand for equities and real assets.
KEITEL’S TOP THEMES
1 Underweight cash and global core bond markets
2 But if you’re going to invest in bonds, look at high-yield bonds and emerging market bonds
3 Overweight the real asset space, chances are you can put more in gold
This story first appeared in the November issue of FinanceAsia magazine
