June 2018: Market news and expert views. We work for your investment

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1 We currently find ourselves in a binary market environment macroeconomic data and corporate profits are very healthy, but political events, especially in Italy, are creating downward pressure. Benjardin Gärtner, Head of Equity Fund Management June 2018: Market news and expert views We work for your investment

2 The markets at a glance The situation in the capital markets currently provokes mixed feelings. The latest quarterly earnings reports, especially those from US companies, elicit a satisfied smile. But a glance at the European bond market can quickly wipe the smile from your face and furrow the brow. The turmoil in Italy is not the only troubling factor in Europe, but certainly an important one. We have therefore decided to proceed with caution in the coming weeks. Our general risk assessment (RoRo meter) has been lowered to a neutral position (from level 4 to level 3) and our equity quota has also been reduced slightly. Not long ago, the capital markets took a very relaxed view of the eurozone. This confidence was founded on impressive economic growth that was steadily picking up and on the fact that various national elections in 2017 had led to a positive outcome (France) or, at least, not to any major upheaval (Germany). The bullish sentiment even persisted for another two months after the parliamentary elections in Italy, which resulted in a relatively large proportion of votes for populist parties but little clarity about who would be able to form a majority government. More recently, however, bond market participants seem to have remembered that a true game changer in monetary policy terms is only a few months away now: In all probability, the European Central Bank (ECB) is going to terminate its asset purchase programme. This is likely to be one of the reasons why risk premiums on (investment-grade) eurozone corporate bonds have increased by as much as 35 basis points in recent months. But the ECB will also cease its purchases of government bonds, which could coincide in an unfortunate way with the delicate political situation in Italy. Against this backdrop, the mood has shifted significantly in the fixed-income market and also in the equity market. Spreads on Italian bonds have widened substantially as, to a lesser degree, have those on other eurozone periphery paper. The yield on 10-year Bunds moved in the diametrically opposite direction, dropping from 0.65 per cent to below 0.3 per cent within a very short period of time. In the coming weeks, the focus in Europe will most likely be more on risks than on opportunities. In other international markets, it may well pay off to take moderate risks for example with regard to US equities and hard currency bonds from emerging markets. Other important news Inflation and monetary policy: The oil price increased, but all in all, there are no signs of a sustained rise in inflation. This is especially true for the eurozone and it is most likely one of the reasons why market participants are expecting rate hikes by the ECB later rather than sooner. We currently see no reason to suspect that the ECB might change its mind about its decision to terminate its asset purchase programme. The adverse impact of political turmoil on the fixed-income market in an individual country such as Italy would not be enough to justify a U-turn on the plans that the central bank had previously laid out. Fixed-income: We have lowered the yield forecast for ten-year Bunds at the end of 2018 from 0.8 per cent to 0.6 per cent based on recent trends. With regard to bonds from emerging markets (EM), we believe there is potential for a reversal of the trend seen in recent weeks. The key requirements for this to happen are that 10-year US Treasuries do not return to yields above 3 per cent and that the US dollar does not continue to appreciate against EM currencies. Equities: The US reporting season lived up to expectations profit growth forecasts for 2018 are around 22 per cent. European companies are performing significantly more weakly, with profits expected to grow by only 7 per cent on average not least because of the recent strength of the euro. And the current political climate and trade-related tensions do little to make eurozone equities more appealing to international investors. Commodities: The oil price (Brent crude) recently dropped by about four dollars as OPEC and Russia seem to be considering a potential increase in production in the second half of But in the medium term, the direct and indirect consequences of the US withdrawal from the Iran nuclear deal could turn out to be more serious than expected (oil production, destabilising effect on the Middle East). Currencies: The US dollar has recently been appreciating against the euro and also against many EM currencies, boosted by optimistic assessments of the US economy. The dollar's exchange rate against the euro has, of course, also been significantly influenced by the unfolding crisis in Italy since mid-may. Political variables make it difficult to predict short-term exchange rate movements, but there are currently no strong indications that the euro will bounce back in the near term. Italian government bonds under pressure Spreads on Italian government bonds over Bunds n 2 years n 10 years Sources: Thomson Reuters, Datastream, as at 29 May 2018, 12.25pm. 2

3 The markets at a glance Our current risk assessment Overall, global growth remains healthy. Leading indicators continue to stabilise. Market participants have shifted their focus back to (geo)political risks (Iran, Italy), which is putting a damper on the mood in the capital markets. (Already low) expectations of interest rate hikes in the eurozone are receding further into the distance. The rise in the oil price has been stopped. OPEC and Russia are considering an expansion of their production in the second half of We have lowered our general risk assessment (RoRo meter) from level 4 (slightly bullish) to level 3 (neutral). RoRo meter Risk Off RoRo-Meter Source: Union Investment, as at 4 June Last changed (from 4 to 3) on 29 May Note: The investment strategy is established by first closely analysing the market environment. The result is reflected in a risk rating. For this, the Union Investment Committee (UIC) expresses a risk-on/risk-off decision at one of five levels (1, 2, 3, 4 or 5). It is to be interpreted as follows: a 5 indicates a strong appetite for risk while a 1 indicates a general withdrawal from risk assets. Risk On Our view of the asset classes Fixed income: Now that a new government has been formed in Italy, we expect the slight upward trend in yields on core eurozone paper to persist. We continue to favour government bonds from emerging markets. Equities: In the markets of the industrialised countries, our preference is currently for US paper. Currencies: The situation in Italy has started to relax a little in recent days and the euro has regained some strength. However, volatility is likely to remain high. Commodities: Positive and negative influences are roughly balancing out in all commodity segments. We have adopted a wait-and-see stance for now. The situation in the money markets remains unchanged. Interest rates are still close to zero and make the holding of cash an unappealing prospect in terms of investment returns. We take a neutral view of absolute return strategies. The outlook for real estate remains positive. Germany continues to be favoured. Appeal of different asset classes Fixed income = Core European government bonds Covered bonds = Eurozone periphery government bonds Corporate bonds (euro-denominated, investment-grade) Corporate bonds (euro-denominated, high-yield) Emerging-market government bonds = Equities = Industrialised countries = Emerging markets = Commodities = Currencies US dollar = Pound sterling = Japanese yen Emerging-market currencies = Absolute return = Cash Source: Union Investment, as at 4 June Note: The table above shows a relative view of a multi-asset portfolio (excluding real estate). If an asset class is more strongly favoured, a lower level of investment in another asset class is required in return. The latter would then be classified as less favoured or vice versa. Real estate is excluded from this analysis. The = signs indicate the change compared with the UIC s previous decision. Not favoured Strongly favoured Neutral Real estate Germany = Europe (ex Germany) = US = Asia-Pacific = Source: Union Investment, as at 31 March Assessment is valid for three months. Note: The table above shows a relative view of the office real-estate markets in light of current market prospects. Owing to data availability, it is only updated quarterly. 3

4 Forecasts These forecasts represent Union Investment s assessment at the current time and may be changed without notice. Where a forecast has been significantly revised in comparison with the previous report, we will explain this in the relevant section. Routine adjustments that arise from a change in the forecasting horizon are not usually explained. GDP Germany Eurozone US Japan China % 2.4 % 2.3 % 1.8 % 6.9 % % 2.3 % 2.6 % 1.1 % 6.4 % % 1.9 % 2.3 % 1.8 % 6.3 % Inflation Germany Eurozone US Japan China % 1.5 % 2.1 % 0.5 % 1.6 % % 1.6 % 2.6 % 1.3 % 2.0 % % 1.7 % 2.4 % 1.2 % 2.1 % 10-year yields Germany US Benchmark rates Eurozone US Current status* 0.4 % 2.9 % Current status* 0.00 % % In 3 months 0.4 % 3.1 % In 3 months 0.00 % % In 12 months 1.1 % 3.2 % In 12 months 0.00 % % Equities DAX 30 EURO STOXX 50 S&P 500 Nikkei 225 Current status* 12,800 3,460 2,740 22,600 In 3 months 13,300 3,650 2,750 23,500 In 12 months 13,800 3,850 2,900 24,500 Commodities Gold Oil (Brent) MS RADAR ex Ag. Current status* 1, In 3 months 1, In 12 months 1, Currencies Euro/US dollar Euro/ pound sterling Euro/ Japanese yen Current status* In 3 months In 12 months Real-estate yields** Germany Europe (ex Germany) 31 March % 3.9 % 4.6 % 4.3 % 31 March % 3.7 % 4.7 % 4.3 % Euro/Swiss franc * As at 31 May ** Data is updated every quarter. The following cities have been aggregated on the basis of regional indices: Germany: Berlin, Düsseldorf, Frankfurt, Hamburg, Munich. Europe: Amsterdam, Brussels, Helsinki, Lisbon, London, Luxembourg, Madrid, Milan, Paris, Prague, Stockholm, Warsaw. US: Atlanta, Boston, Chicago, Dallas, Houston, Los Angeles, New York, Miami, San Francisco, Seattle, Washington. Asia-Pacific: Tokyo, Kuala Lumpur, Singapore, Seoul, Sydney. US Asia-Pacific 4

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