The ideal portfolio for investors in the euro zone: Equities and a hedge against inflation

The long period of low risk-free interest rates in the euro zone has led investors to switch into risky assets (corporate bonds, real estate, peripheral sovereign bonds), squeezing the risk premia on these assets. Euro-zone equities are the only exception: the equity risk premium remains very high, which ought to lead investors to overweight European equities. The risk is that a rapid rise in long-term interest rates could cause share prices to plummet. This would result from an unexpected rise in inflation in the euro zone (for example due to a spike in oil prices) or a rise in US long-term interest rates related to possible changes to labour market policy. Portfolios should therefore also include a hedge against resurgent inflation (inflation-indexed bonds, for example).