Right now, central banks are keeping growth and equity markets afloat – assisted by consumers. Despite a minor tsunami of uncertainties washing over the world, we still see a decent return potential in equities relative to other asset classes, though the value of bonds in your portfolio is difficult to overestimate at the moment.
The above is the overall conclusion of Danske Bank’s new quarterly report, Quarterly House View, where Anders Svennesen, co-CIO in Danske Bank Asset Management, assesses the current opportunities and threats for investors. You can read the report here.
Despite the many political and geopolitical uncertainties at the moment, including the trade war and Brexit, Danske Bank is maintaining a slight overweight in equities and a corresponding underweight in bonds.
“We remain convinced that the global economy, despite everything, is still moving in the right direction below the choppy surface waters, even though uncertainty is much greater than six months ago. Private consumption is still supporting the economy, driven by high levels of employment and rising wages, while the trade war and slowing growth have persuaded central banks to ease monetary policy. Figuratively speaking, this provides a very essential vitamin infusion to the global economy – and hence also to our expectation that equities will continue to have a greater return potential than bonds,” says Anders Svennesen.
We see greatest potential in the US
Our co-CIO expects that US equities will give the highest return in the coming year.
“We have seen how US equities have so far generally outperformed other equity markets when the trade war has escalated, plus consumption appears strongest in the US. This justifies the higher valuation on US equities relative to other markets, just as the higher valuation is also reflective of the US having more growth companies within technology, etc. Moreover, the US central bank, the Fed, has more ammunition at its disposal than the European Central Bank, for example,” he notes.
While yields are very low, Anders Svennesen nevertheless stresses just how important it is to have bonds in a portfolio to act as lightning rods should equity markets suffer a major price fall. In such cases, prices on the most secure bonds, such as Danish or German government bonds, typically hold their own or even rise.
“Just as monetary policy provides a vital vitamin infusion for the global economy, bonds are the supplement that keeps your portfolio strong and healthy – and there could be an additional need for that in the coming months, when we will probably continue to experience significant price volatility in equity markets,” he says.
Attractive bonds in emerging markets
However, bonds are not only about stability. At the riskier end of the bond markets, Anders Svennesen sees an attractive return potential in emerging market bonds, primarily government EM bonds. These can potentially give a considerable excess return relative to more secure bonds.
“While we often see challenges in particular emerging market countries, such as Argentina at the moment, our assessment is that the bond class as a whole is currently quite healthy and supported by generally solid government budgets and declining yields in the US,” he says.
Lower US rates and yields are positive for the many developing nations with dollar-denominated debt, and Anders Svennesen sees the greatest potential in emerging market bonds issued in hard currency, such as dollar or euro. At the present time they give an average yield of 5.3%, whereas most Danish and German government bonds have negative yields – though of course the risk with emerging market bonds is also considerably greater.
“The trade war drawing out or escalating further could undermine emerging market economies and result in price falls on EM bonds, but on the other hand we expect that investors’ continued search for return in a low-yield environment will help support the asset class,” he says.
Danske Bank has prepared this material for information purposes only, and it does not constitute investment advice. Always speak to an advisor if you are considering making an investment based on this material to establish whether a particular investment suits your investment profile, including your risk appetite, investment horizon and ability to absorb a loss.