Bank Austria Creditanstalt Asset Allocation for Q3 2006:
Risk aversion on the markets has risen

  • Inflation, oil, disappointing company figures, the Middle East as themes
  • Therefore: strategy becomes more defensive, equity weighting now only neutral

The correction on the international stock markets which started in May continued at the beginning of the third quarter. On the one hand, geopolitical issues have come to the fore again (violence in the Middle East), on the other, the reporting season in the USA has clearly been mixed so far. Against this background an increasing amount of capital flowed into government bonds, with yields returning during the first three weeks of July both in the USA and Europe. In Japan the central bank joined the international concert of interest rate hikes and raised the key interest rate to 0.25 per cent.

Our interest rate expectations: In the USA we see a further increase of 25 basis points to 5.5 per cent, and expect the first interest rate cuts in early 2007. In euroland we see two further hikes by 25 basis points before October, bringing the interest rate to 3.25 per cent.

On the stock markets there is an increasing trend toward risk aversion. Investors are reducing their exposures in higher risk investment vehicles (e. g. stock exchanges in emerging markets, technology stocks etc.), instead preferring government bonds or, within equities, defensive sectors such as pharmaceuticals, telecoms or utilities.

The commodities markets have also shown robust signs of life recently, after the upsurge in prices faltered in spring. The flare up of violence in the Middle East has resulted in rising oil prices, while at the same fuelling demand for gold as a safe haven in uncertain times.

As historically speaking, the third quarter is not one of the best on the stock exchanges, we have made allowances for this and given our strategy a rather more cautious orientation. Measures range from reducing the equity weighting to scaling down exposure in the emerging markets. Overall, these measures should underline the fact that we have taken into account this increased aversion to risk in our strategy.

The same applies to our list of recommendations, which also has some highly defensive features this time. From the pharmaceuticals industry we have placed Novartis on the list, together with the utility eon and tobacco company Altria (formerly Philip Morris). These three positions span the almost classic defensive spectrum. In Europe they are joined by the energy stock Total (rising oil price, hurricane season), and the British supermarket chain Tesco. Our only really cyclical recommendation, to round off the portfolio so to speak, is the conglomerate GE.

Asset Allocation:
The recently increased aversion to risk on the international stock markets is fundamentally driven by the fear that rising inflationary pressure could prompt central banks throughout the world to set a more aggressive pace in their interest rate hikes. The latest wave of violence in the Middle East has also brought "geo-political risks“to the forefront again. After three years of excellent performance on international markets, we are now taking account of this new stronger risk awareness and reducing the equity weighting to neutral, i.e. 40 per cent. Accordingly, bonds and debentures account for 57 per cent, cash for 3 per cent.

The theme "increased risk aversion" is also continued in the detailed share and bond portfolio. On the bond side we have reduced the item "rest of Europe", which also includes CEE, from 10 per cent to 8 per cent. Accordingly, we have increased the weight of euroland bonds from 79 to 81 per cent. In the dollar segment we remain underweighted, whereby the depreciation of the dollar has slowed considerably recently.
Volatility in the asset category shares has recently increased significantly, with profit taking in precisely those segments which had previously reported the sharpest increases. To this extent, risk aversion is also having an impact on the country allocations within the equity weighting. We have trimmed our exposures in "other countries – emerging markets" from 10 to 8 per cent. In return, Japan has been increased from 12 to 14 per cent in the equity segment. Following the latest price declines we see attractive opportunities in Japan, and expect the country's essentially positive fundamentals to feed through to impact corporate profitability.

Enquiries: Bank Austria Creditanstalt Asset Management
Monika Rosen, Head of Research, Tel. (01) 33 147 ext. 5403
E-Mail: monika.rosen@amg.co.at