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The macroeconomic data flow remains generally upbeat. But risks to global growth have increased due to the rising and spreading tensions in the Middle East. In the eurozone, no comprehensive solution the ongoing debt crisis is likely to emerge: we expect Portugal to be forced into the safety net, when attention will shift to Spain (while Italy is looming on the horizon). In short, the market is complacently ignoring some important potential negatives. As a result, we do not expect the equity market to set new highs in the short term.
As the negative spillover from higher oil prices to cash earnings in the real estate sector is limited and will only materialize with a substantial time lag, we currently prefer real estate to equities.
Corporate bonds spreads continue to tighten, based on the favorable economic environment, ultra-low default rates and generally improving credit quality. Against this constructive macro backdrop and given the relatively high quality of outstanding debt, the spreads on credits and high yield have some way to go before they reach fair value. We do not expect valuation to hinder further outperformance of credits versus government bonds or high yield versus cash.
Though there is a risk that the spike in oil prices will prove to be temporary, it should be noted that oil prices have been in an upward trend since the middle of last year. We expect continued economic growth, combined with generally tight supply, to drive commodity prices higher.
At the current level, oil is not going to set back the economic recovery too much, which is why we still prefer cyclical sectors to defensive ones within equities. Further rises in the oil price could trigger a change in this outlook, however.
In this month’s special feature, we look at the threat of commodity price inflation. We consider a renewed spike in commodity prices likely in the next few years.