Deutsche wealth unit keeps historically low developed equities exposure

The global investment committee behind Deutsche Bank Private Wealth Management has kept a recommended weighting to developed world equities at just 9% late in September, reflecting a sombre outlook on advanced economies’ prospects.

On 27 September the 13-member committee’s recommendation for emerging markets shares was almost double that – 14% – with 21% in cash.

Traditional equities and private equity comprise 28% of a recommended portfolio. Some 48% was in fixed income and cash, and 24% was in infrastructure, real estate, absolute return strategies, commodities and FX.

Kevin Lecocq, DBPWM global chief investment officer and a member of the committee, said: “Until the complex counter-currents begin to subside, we recommend a cautious stance in the markets for most of our clients. Things could still go horribly wrong – benign outcomes are far from guaranteed.

“For deep-value investors with a long time horizon, however, the third quarter sell-off presents an excellent entry point to buy great companies, and emerging market debt and currencies.”

Paul Wharton, DBPWM’s chief investment strategist UK, encouraged investors to show “willingness to look through the short-run outlook to see the bigger opportunity”.

He noted markets already seemed to be pricing in a mild recession “so there may be some real upside potential in equities for long-term minded investors.

“In the near term, however, the combination of the ongoing reassessment of 2012 earnings, coupled with rising risk aversion – which translates into downward trending P/Es – should lead to caution as we are not yet at a stage where a severe recession is reflected in the numbers.”

Near-term uncertainty about various asset classes and markets/economies sits behind much of DBPWM’s committee’s cautious allocation.

Wharton said internal funds available to US non-financial firms are at 30-year highs, equivalent to 9.9% of US GDP, so corporate balance sheets were not leading to concerns over growth. “What is missing is confidence in the economic outlook.”

Similarly, he said major European purchasing managers indices – heading downwards – suggest stagnation this half.

The indices are “pointing downwards not only in the peripheral eurozone economies, where fiscal adjustment is pulling down GDP growth, but also in Germany and France.”

He noted risk aversion had hit emerging markets – equity, bond and FX – “but, for most Asian and some Latin American markets – for example, Mexico – we think that the weakness is likely to be temporary.”

A briefing note published by DBPWM said the European Commission had pointed to a doubling of European public debt to GDP ratio by 2031, and European GDP was at the same level in the second quarter, as it was in 2007, in real terms. Only Germany has expanded its economy since, by 2%; France has not grown, and Spain and Portugal sit 2% to 3% below 2007 levels.

Additionally, eurozone savings rates shrunk 10% from 2009 to 2011, and “with consumer confidence on a downward trend in the third quarter, less household spending support for growth should be expected in the near future”.

Will it be a European recession, or just slow growth?

Writing before Slovakia voted against expanding the bailout fund, DBPWM said ‘slow growth’ was more likely, but weakening of political resolve to fix the mess was a threat to any growth.

In the US, year-to-date earnings revisions for S&P 500 companies have been upwards 3.2% – energy up 26% and materials up 12% leading – but over three months revisions have been downwards, lead by financials.

DBPWM hinted Asian equity investments may not provide fully safe harbours if Western markets suffer.

“Asian equities are unlikely to decouple from developed market equities in periods of market downturn. They could, however, benefit from a higher rebound when markets are moving upwards, given their high volatility.”

In the meantime, DBPWM’s global investment committee notes there is a “high rotation” in what investors view as suitable safe assets – demonstrated by changing preferences for Brazil, gold, and the US dollar. “It is indeed very difficult to identify a safe haven and even cash, in the light of current uncertainties on currencies, does not look like a particularly good solution.

“We therefore consider that dynamic tail risk monitoring and hedging are paramount.”

For equities, high dividend stocks in non-cyclical sectors may be one option; for fixed income, avoid long-duration bonds or “dubious sovereign risk such as the southern European countries but also, on the margin, France”, underweight financials; and, among commodities, focus on oil and food.

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