Why is Draghi’s speech remarkable? What are the reasons that real estate could continue to outperform? Why do we think that the euro will weaken further? The expected course of the euro is one of the reasons why we like German equities. We hold on to our medium underweight European equities.
## Real estate equities offer an attractive dividend yield
Source: Thomson Reuters Datastream, ING IM (August ’14)
## The ECB preached a bit of a revolution
In a remarkable break with the ECB’s past, the ECB President stressed that the current high levels of unemployment justified action on both sides of the economy, as not only structural reform of the supply side is needed (as always emphasised by the ECB) but also aggregate demand support is desired. Draghi even admitted there is a large probability that the cyclical unemployment will become structural and implied there is a task here for monetary policy to counteract this. While this line of thinking is quite normal within Anglo-Saxon central banks, it can be seen as a bit of a revolution at the ECB.
## Our base case is that ECB will start sovereign bonds (QE)
Our base case now involves a sovereign QE program to be implemented in the next six months. However, the risks are firmly tilted in the direction of the ECB not delivering, due to a failure of core central bankers to agree on this.
## The global sweet spot: real estate
Investors have embraced real estate for its attractive (real) yield and the case still stands. Often, the yield on real estate is compared with corporate bond yields or junk bond yields. Of course, as soon as you start to compare with fixed income instruments the comparison becomes favourable for risky assets. The difference between real estate yield and high grade corporate bonds is above its 10-yr average (1.8% versus 1.2%). This gives us an idea of the buffer against rising interest rates, provided this happens at a gradual pace. As long as the Federal Reserve maintains its monetary policy path and both the ECB and the Bank of Japan keep their easing bias, we see little or no danger for a 2013-like sell-off in global real estate.
## Why we changed our view on the euro
With respect to short-term market rates, we notice that 2-year German bond yields and two year swap rates dropped into negative territory. Against this background, we change our view on EUR/USD. We no longer expect EUR/USD to trade around 1.35 in the next few quarters, but see it weakening towards 1.28 early next year.
## Lower euro is favourable for German equity market
For European-based investors things may feel worse than they actually are, as the global equity environment remains supportive. We must not forget that the European equity market represents only a quarter of the MSCI AC World index and that many of its constituents have exposure to those parts of the world where growth is healthy or improving (US and emerging world).The recent weakening of the euro is a clear positive for exporters and explains partially our overweight Germany. Recent underperformance and cheap valuations are the other factors favouring Germany.