Edmund Shing:

Hello and welcome to new podcast from BNP Paribas Wealth Management. I'm Edmund Shing, Chief Investment Officer. In this podcast, I want to answer three more questions from our clients that we have recently received. 

The first question is the following: Has the German sovereign bond yield peaked and is now a buying opportunity? 

So to put it into context, over the last year and a bit, the German ten-year bund yield, so that's the government bond yield for Germany, has risen by about 1 percent, peaking at over 3.1 percent recently. It's still over 3 percent at the time of recording, and has even risen 0.4 four percent over the last six weeks since the beginning of March, which marked the beginning of the current Iran conflict. So the German bund yield has gone up quite a bit, and if we look at decomposing that 3.1 percent into the two component parts, you basically have a real yield, which is the real underlying yield over the long term, and then you have an inflation expectations component, which prices in what the market expects German or European inflation to be over the next ten years. 

So if we look at the two parts, the inflation component is priced at around 2.3 percent at the moment, and the real yield, which we can gauge from using inflation-linked bonds, is trading about 0.7 percent. That is not a bad level at all. I think firstly we should be confident that the European Central Bank, the ECB, will maintain long-term European inflation close to its 2 percent target. So I think the 2.3 percent expected inflation over the next ten years is more than fair, and the real yield component, the 0.7 percent, is considerably higher than it has been in the past. I mean a few years ago it was solidly in negative territories. So you know we have seen the real yield rise quite sharply. 

In the medium term, we would expect the German bund yield to range between 2.7 percent and 3 percent. So right now we're at very much the top of this range, and honestly speaking, we think that this is a buying opportunity. We have turned positive on German government bonds right now at over 3 percent. We do believe that the yield will probably fall, particularly upon any conclusion of the Iran conflict, at least a ceasefire, and most importantly the resumption of traffic through the Strait of Hormuz, which will then ease inflationary pressures for the remainder of this year and into 2027. I think that is the key. 

Now we are more positive on German government bonds than other government bonds within Europe because over the last year we have seen what we call the spreads, the difference between German government bonds, which typically are the lowest in the eurozone, and others such as Spain, Italy, Portugal, Greece, France. We’ve actually on average seen the spreads between these government bonds and the German government, shrinking. So we would argue that these the other eurozone country government bonds are perhaps not quite as good value as the German at the moment, which is why we have a preference for core eurozone bonds such as Germany right now. 

Question 2: Is the evaporation of the tech valuation premium leading to multi-year lows a good entry point today? 

To put this again into context, AI does remain the main driver of growth in the tech sector for sure. U. S. Hyperscaler AI capex continues to inflate for this year, so expectations for the four major hyperscalers are 660 billion dollars, to which we can then add additional capex requirements from non-listed companies such as Anthropic and OpenAI. The ongoing optimism is fuelled by the launch of new power model AI agents from Anthropic and Meta, as well as positive statements from AI heavyweights such as Anthropic. 

So Anthropic themselves recently stated that its run rate revenue should soon surpass 30 billion dollars. So again, there's still a lot of optimism around the growth rate and around the ultimate profitability of these AI models. This comes on the back of increasing uptake of AI tools by the corporate sector, specifically from smaller companies. So there's a lot of demand from SMEs. And given the re-rating and the structural growth opportunity that the IT sector represents, we are now seeing increasing value in the sector. 

To give you one example, just a few months ago, Microsoft, one of the heavyweights in the tech sector, was trading at 33 times forward PE, and that has shrunk to just 22 times forward PE. So the valuation has been cut by a third in just a few months, particularly over the worries over AI disruption to hitting the software sector, of course, and that has not spared Microsoft. So we have had a compression of valuations across most of the tech sector over the last few months, and we do think that this actually generates some interest, and investors should look again, finally, at some of these tech sector companies. 

Again, you will need to be selective because there will be some companies that will be disrupted by AI. I personally think that there a quite a few of the heavyweights of the very well-established companies like Microsoft that are unlikely to suffer that much from AI, in fact, could be a long-term beneficiary. But at the very least, we don't think that they're going to suffer that much and will continue to grow over the next few years, regardless, and will probably turn in pretty strong results over the next few quarters. Selective ideas, yes. Would we buy the whole sector? For instance, would we just go buy the whole Nasdaq 100 index? No. We think you still should proceed with some caution, as the current market environment still remains quite uncertain, despite the impressive rebound of global stock markets over the last couple of weeks. 

Question three: What is the impact of disruptions in oil products, aluminium, or helium on corporate earnings?

Well, look for us the three ways in which corporate earnings can be impacted by the disruptions to these raw materials, the supply of raw materials from the Gulf. 

Firstly, the share of total input cost dependent on these products, such as aluminium, helium, or gasoline, jet fuel, diesel, will all depend on the availability or not of ready substitutes. For something like helium, for the semiconductor sector, there really are no ready substitutes, as one example. However, in other cases, such as natural gas, there is there are available substitutes for electricity generation, such as switching temporarily to coal. 

The degree to which the producer commands pricing power is a second element, very important in determining each company's ability to defend profit margins at a time when some of these raw material input costs are going up, or at least maybe temporarily higher. But the ultimate cost impact will vary widely across industries and geographies. Coming back to the example of helium with the semiconductor industry, yes, it's crucial for the manufacture of semiconductor chips, but the impact on the overall cost of making a semiconductor chip from a price rise in helium should be relatively modest, as helium generally represents between 0.5 percent and 1 percent of production costs. So it's not the biggest element. 

Secondly, think about operational constraints. So due to supply shortages, these will pose a bigger threat if the Gulf-related disruptions persists and if stocks become depleted over time. And thirdly, there is a negative effect on falling production volumes. Although we do expect rising prices to compensate any such effect, at least partially. 

So again, it's very difficult to judge. At the moment corporate earnings seem to be suffering relatively little impact, and the U.S. earnings season has started pretty well so far. We would expect the impacts probably to come in subsequent quarters, but even then, this will depend on how long-lasting the supply disruptions from the Gulf are, and as usual, how quickly the Strait of Hormuz is reopened to maritime traffic to allow these products to leave the Gulf and go to Europe, U.S., Asia, wherever they're needed. 

Those are the three questions for this week. Thank you very much for listening to our podcast, and please like, share, and subscribe to our series of podcasts at BNP Paribas Wealth Management. And until the next time, thank you very much for listening, and goodbye.