Market outlook December 2018

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We took advantage of the decline in equity prices in October to go overweight in equities in the portfolios. The prerequisites for this overweight have not changed. This is based on the fact that growth and earnings are still satisfactory, that the fiscal policy in several countries is supportive and that interest rates remain low. However, we must anticipate larger fluctuations than we have been accustomed to in recent years. This is a natural development during the later stage of the economic cycle. In our equities portfolio, we are moving European equities from an overweight to a neutral weight.

Allocation between fixed income and equities

Last month, we moved to an overweight position in equities in the portfolios. We wanted to take advantage of the fall in the stock market to buy shares. The equity valuation had become more favourable. Since we went overweight, the markets have risen somewhat with the exception of Oslo Børs. The prerequisites for the overweight position have not changed. When it comes to geopolitics, the conditions are currently looking better. The US has eased the sanctions against Iran. There is also a G20 summit this coming weekend, gathering leaders from the world's largest economies. The trade conflict between the US and China will most likely be a topic at the meeting. Since the US has eased the sanctions against Iran somewhat, it could look like the US is more willing to not let the trade conflict evolve further, but the signals are mixed.

Global growth appears to be slowing down. This is most visible in leading indicators, which serve as an indication of future growth impulses. It is nonetheless widely expected that global growth is likely to slow down by around one tenth from 2018 to 2019. The big question is whether the decline will be significantly larger than that. An important part of the answer to this question will be to assess Chinese growth. We are quite optimistic with regard to Chinese growth in 2019, as the authorities have implemented major simulative measures, partly to compensate for the growth-weakening effects of the US trade policy. Satisfactory global growth combined with more reasonable equity pricing following the corrections in the autumn points towards maintaining the overweight in equities versus fixed income.

The overweight that we have in equities is financed by underweighting global investment grade bonds. Such bonds now yield an effective interest rate of 3.4 per cent, which is around 0.3 percentage points higher than in the summer. The rise in interest rates is not enough to make such bonds more attractive compared to equities.
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Fixed income

As we are entering December, we are not making any changes to the fixed-income portfolio. For a long time, we have been very well positioned for a rise in global interest rates, by owning bonds with short rather than long maturities.

Equities

We are moving European equities from an overweight to a neutral weight. Europe is the region with the weakest development in macroeconomics. We see the same situation when we look at companies' earnings. At the same time, we want to make the cyclical exposure in the portfolio wider. We do this by investing in the materials and industrial sector.

At the beginning of October, the oil price was USD 85 per barrel. The price is now at USD 60. That is a decline of almost 30 per cent, and we have to go back to October 2017 to find a similar level, as shown in the figure below.
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In light of the substantial decline, we have again reviewed our overweight position in Norwegian equities and the energy sector. In this context, it is important to find out whether the price drop is due to challenges on the supply side or the demand side. Challenges related to demand are more serious, as they may indicate weaker economic growth. As we see it, it is first and foremost the supply of oil that has changed. One month ago, it was expected that the Iranian export of oil would decrease by 1.2 million barrels per day. However, the Trump administration has made exceptions from the sanctions against Iran, allowing eight countries to import oil from Iran after all. The shortfall of oil supply will thus not be as significant as expected. It was this amendment from the US government that accelerated the drop in the price of oil. The demand for oil is more stable. Over the last few years, it has gone up by approximately 1.5 per cent per year. We have no signals indicating that this growth will stop. If we also look at the spare capacity in the world's oil production, we find that it is approximately 1.5 million barrels per day. Spare capacity means the production of oil that can quickly be supplied to the market. A spare capacity of 1.5 million barrels is less than the average for the last 10 years. In other words, the oil market is vulnerable to challenges related to production. Considering the small spare capacity and the stable demand for oil, we find the latest oil price drop to be too large. We are therefore maintaining our overweight position in the energy sector and Norwegian equities. A weak Norwegian krone also makes Norwegian equities more attractive.

Apart from downgrading European equities we are not making any changes to our equities portfolio. In addition to maintaining the energy sector and Norwegian equities, we are overweighting equities in emerging economies. We are also maintaining our overweight position in finance and technology. The first-mentioned overweight is justified partly by our belief that interest rates will go up in the long term and partly by the reasonable valuation of the sector. The valuation of the technology sector has become more reasonable after the recent price correction. This, combined with the fact that we are considering the technology sector to be in a structural tailwind, is what has prompted us to maintain our overweight position.

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