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Bank Austria Creditanstalt Asset Allocation for Q1 2007: Successful start to new stock market year

  • Overall conditions remain good, spotlight on central banks
  • Key issues: mergers, oil price and earnings

After what in principle was a very pleasing stock exchange year in 2006 the equity markets have kept their momentum going into the New Year, even though the very first trading days were somewhat volatile. Nevertheless, the general conditions are paving the way for this rally to continue. Economic growth in Europe this year is expected to remain robust, while the USA is heading towards a "soft landing", i.e. a slowdown in growth without a recession.

But what investors are most interested in are the policies of the central banks around the world. We anticipate that the ECB will raise interest twice within the first six months, each by 25 basis points, while it is still up in the air when the Fed will decide to make its first move to cut interest. The US figures published most recently (e.g. retail sales) tended to exceed expectations, and as such we could have to wait until late spring or early summer before the first cut is made. Under such circumstances yields could start rising again, particularly in the USA, i.e. the bond markets may weaken slightly.

Equity prices continue to benefit from the extremely good corporate results, vibrant merger activity and also from the low price of oil. Since the beginning of the year the oil price has been spiralling downwards, which although does not benefit the prices of oil stocks, it does stimulate the rest of the market, since it curbs inflation. And the fact that earnings have risen more strongly than prices in recent years continues to keep the valuation of most of the equity markets attractive.

Nonetheless, one cannot rule out the risk of a short-term correction or consolidation particularly as the year goes on, especially since the upwards trend has been ongoing since 2003, essentially without any lengthy interruption. Accordingly, in our current list of recommendations we overweight defensive stocks. The pharmaceuticals company Novartis and UK household appliances manufacturer Reckitt Benckiser lead the European recommendations, followed by Deutsche Bank. Given its strong focus on investment banking it is likely to benefit from the boom in merger activity. With Pfizer and the tobacco company Altria the USA also has two defensive stocks on the list, while GE represents more of a bet that the positive economic surprises will continue.

Asset Allocation:
The equity markets have recovered well from their setback last spring and are still benefiting from the strong wave of mergers and acquisitions as well as the fading inflationary concerns. The growth rates of corporate earnings are also still higher than expected. We have taken note of these positive developments and lift our equities weighting a touch to 42 percent. This brings our equities weighting to slightly above the neutral level of 40 percent, which well reflects our fundamental approach of being cautiously optimistic. Moreover, the valuations on the stock exchanges are still attractive and this also advocates investing in equities. On this basis our allocation for Q1 2007 is structured as follows: equities 42 percent (slightly overweighted), bonds 55 percent (slightly underweighted) while cash remains unchanged at 3 percent.

This time round there are no changes in the bond portfolio. We uphold our strong overweighting in euro bonds (84 percent), since we still do not assume that the euro will weaken to any major extent. Dollar bonds remain at 5 percent and thus heavily underweighted. The rest of Europe (incl. CEE) is weighted at 5 percent, with the UK marginally higher at 6 percent.
We are upping our weighting of Europe in equities too by raising the UK from 9 to 11 percent. We have identified a range of opportunities on the UK market which we would like to take advantage of. Furthermore, this means we are over- or at least neutrally weighted in all European markets (euro area, UK and the rest of Europe). Weightings have been brought down in the USA (from 46 to 45 percent) and in Japan (from 13 to 12 percent). The modest reduction of the equities weighting in the USA again reflects our approach to the dollar, which remains cautious. In 2006 Japanese equities tended to underperform. In spite of this, sticking with 12 percent we maintain our slight overweighting to the benchmark, since in light of the ongoing economic recovery in Japan we are betting on improved opportunities in the New Year.

Enquiries: Bank Austria Creditanstalt Asset Management
Monika Rosen, Phone (01) 33 147 Ext. 5403;
E-Mail: monika.rosen@amg.co.at