Our preferences to guide your asset allocation

Guidance on asset allocation based on our current assessment of the global economy and financial markets.

+ Overweight

Tactical recommendation to hold more of the asset class than specified in the moderate risk strategic asset allocation.

- Underweight

Tactical recommendation to hold less of the asset class than specified in the moderate risk strategic asset allocation.

= Neutral

Tactical recommendation to hold the asset class in line with its weight in the moderate risk strategic asset allocation.

 

Note: This is a visual summary representation of our positioning. Please visit the full monthly report for our full detailed asset allocation tables.

Equities

We are holding on to a moderate emerging market equity underweight, with a preference for carry assets, such as EM sovereign bonds and selected EM currencies. While there has been more optimism in recent days around a potential interim deal to defuse US-China trade tensions, we are skeptical that this is sufficient to lift corporate confidence. The escalation in the trade dispute poses a significant risk to emerging markets, with earnings being affected directly via tariffs and indirectly via slowing economic activity. We maintain our neutral position toward US equities, but continue to prefer them to other regions based on superior US growth. The US has more tools to stave off a macro slowdown. The Fed has more scope to cut interest rates than other major central banks, and the federal government is more willing to increase budget deficits. While the US economy is decelerating, leading indicators suggest a low risk of recession. Lower interest rates ahead should provide a further tailwind. We keep our underweight to international developed market equities, particularly to Eurozone equities.

We are neutral US equities but prefer it to other regions based on superior earnings growth versus other regions. The US also has more tools to quell a potential macro slowdown. The Fed has more scope to reduce interest rates than other central banks, and the federal government is more willing to increase budget deficits. While the US economy is decelerating due to fading fiscal stimulus and the lagged impact of higher interest rates, leading indicators suggest a low risk of a recession and lower interest rates should become a tailwind. We expect 1% earnings growth in 2019, picking up to 5% in 2020 as headwinds from commodity prices and the tech sector abate. Valuations appear fair, in our view, in the context of still-healthy growth and low inflation.

We maintain benchmark allocations to both growth and value. Economic growth is moderating and we believe the US economy has entered the late stage of the business cycle. Both of these factors favor growth stocks. Value tends to perform best when economic growth is accelerating and corporate profit growth is strong. By contrast, growth stocks tend to perform best later in the cycle when investors begin to worry about the durability of economic growth. Still, investors already seem to more than appreciate that the environment slightly favors growth companies given that relative valuations for growth stocks are extremely elevated relative to value stocks. As a result, we believe a neutral allocation makes the most sense.

We maintain benchmark allocations to both growth and value. Economic growth is moderating and we believe the US economy has entered the late stage of the business cycle. Both of these factors favor growth stocks. Value tends to perform best when economic growth is accelerating and corporate profit growth is strong. By contrast, growth stocks tend to perform best later in the cycle when investors begin to worry about the durability of economic growth. Still, investors already seem to more than appreciate that the environment slightly favors growth companies given that relative valuations for growth stocks are extremely elevated relative to value stocks. As a result, we believe a neutral allocation makes the most sense.

We believe we are now in the late stage of the business cycle. Typically, large-caps outperform small- and mid-caps in the later stages of bull markets, as smaller companies have a harder time adjusting to inflationary pressures and higher interest rates. However, investors seem to already appreciate some of these risks given that relative valuations for small- and mid-caps are somewhat low relative to history.

We believe we are now in the late stage of the business cycle. Typically, large-caps outperform small- and mid-caps in the later stages of bull markets, as smaller companies have a harder time adjusting to inflationary pressures and higher interest rates. However, investors seem to already appreciate some of these risks given that relative valuations for small- and mid-caps are somewhat low relative to history.

Within international developed markets, we are neutral on Japanese stocks. The market looks attractively valued. Since the start of the year, Japanese stocks are up 10%, compared with a gain of 16% for global equities. Consensus earnings continue to see downgrades, but earnings growth should stabilize next year.

Within international developed markets, we are neutral on Swiss stocks. Switzerland is the most expensive market in our coverage universe, trading at a 13% premium to global equities on 12-month forward P/E. However, earnings growth in the region continues to show resilience to the global slowdown.

Within international developed markets, we are neutral on Australian equities. Valuations do not look attractive but they may still benefit from Chinese fiscal and monetary policies. In addition, the RBA's current easing mode is likely to limit banks' earnings growth.

Within international developed markets, we are neutral on Canadian equities. The current 12-month forward P/E is below historical averages. Economic growth, however, shows some weak spots and consensus estimates on energy earnings remain vulnerable to downward revisions on the back of lower oil prices and pipeline capacity restrictions.

Within international developed markets, we are neutral on UK equities. While the UK was formerly seen as a conservative, lower-risk market, prolonged Brexit uncertainties could change this characteristic and lead to a rising risk premium. The long-term risk outlook for UK equities remains uncertain.

We are neutral on Japanese equities but continue to prefer them within international developed market equities. They have lagged other cyclical markets since the beginning of the year, limiting downside risks and providing rerating potential if global data were to improve from here.

Even considering our weak earnings growth forecasts for FY2019 at -4% due to an escalation of trade tensions and yen appreciation, valuations continue to look attractive, in particular compared to Eurozone equities.

We expect an earnings recovery in the December quarter, largely due to base effects. Given our recommendation that investors hold exposure to Japanese equities on an unhedged basis, yen strength benefits the position. Emerging market

Emerging market (EM) equities rebounded around 6% from their August lows as US-China trade tensions eased. On the back of this development, EM equity funds saw inflows for the first time in four months. Economic data, however, remains weak. Although manufacturing activities have shown signs of stabilization, China investment data remains soft. Valuations are above their historical averages and we see limited room to the upside, given the still-high trade uncertainty and weak global macro backdrop. Hence, we are underweight EM equities in our global portfolio. Among emerging markets, we maintain our overweight Brazil versus underweight Mexico, overweight Mainland China versus underweight Hong Kong and overweight Malaysia versus underweight Thailand.

Bonds

The US Treasury 10-year yield reached 1.80% in October on the back of better news out of China and the UK. We believe yields will remain range bound through the end of the year and the recent yield curve steepening will persist as the Fed begins buying T-bills and a potential new 20-year Treasury security comes to the marketplace. Volatility will remain high into year end, but we look for rates to remain within their 1.5-1.9% range.

In more-aggressive portfolios, we recommend an allocation to long-duration Treasuries to help protect against equity market volatility.

The TIPS market has witnessed an uptick in performance as the risk-off sentiment abates. The status quo news from the China-US trade tensions and likely Brexit deal has led to a decline in the safe-haven appeal of nominal US Treasuries. We continue to prefer 5-year TIPS over 5-year Treasuries. New 5-year TIPS were auctioned in October and were met with strong investor demand. We believe TIPS are set to outperform given the market’s low inflation expectations versus the fundamental data, particularly as we turn a new year.

Munis are holding up relatively well despite some weaker technical now present in the fourth quarter. Over the past few weeks, tax-exempt paper has declined by a modest amount (-0.1%). New issuance has increased, as is often the case at this time of year. At the same time, municipal bond mutual funds have now attracted net cash for 41 consecutive weeks. In credit, we continue to favor investment grade munis rather than lower-rated high yield credits based on tight credit quality spreads.

We remain neutral on IG. While corporate leverage among US issuers has surpassed previous peaks, we think there are strong mitigating factors such as persistently low interest costs and high earnings margins. We believe aggregate credit quality is not a key risk for now, in the absence of an economic recession. We continue to favor financials (US banks) over non-financials due to their strong credit profiles. In addition, IG corporates with short maturities (1-3 years) provide attractive yield relative to their low duration.

As the US and China agreed to a partial trade deal in principle, HY credit spreads tightened toward the midpoint of their trading range in 2019. We maintain a neural allocation to HY bonds. Credit spreads should remain contained until yearend, given accommodative monetary policy globally, record amounts of negative- yielding bonds, and the pervasive search for yield. Looking into 1H20, we expect credit spreads to widen as the full impact of trade tariffs causes global growth to slow and fundamentals to weaken. We expect the HY default rate to gradually rise to around 3% over the next year from 2.7% at present.

Over the past month, bond yields have moved mostly higher in non-US developed markets. On foreign exchange markets overall, the dollar depreciated against other major currencies, helping returns when measured in dollars. These factors offset each other, leaving the asset class little changed for the month. With yields still negative on many bonds, non-US developed fixed income remains unattractive. We do not recommend a strategic asset allocation position on the asset class.

EM corporate and sovereign credit delivered year-to-date gains in the low-to-mid teens on tighter spreads and significantly lower Treasury yields. The asset class also benefited from dovish central banks and continued Chinese stimulus measures, despite a more uncertain global environment. We expect spreads to trend sideways to slightly wider, with further bouts of volatility. Global macro and geopolitical risks remain elevated, but dovish central banks appear as a supporting factor. We are tactically overweight emerging market (EM) USD-denominated sovereign bonds as we think the current macroeconomic environment favors carry strategies.

Emerging market stocks are geared to the global economic cycle and heavily exposed to an escalation in trade tensions. Inflation in the region is moderating, central banks are easing policy, and while growth is slowing, there are no immediate signs of a hard landing. That backdrop is supportive for bonds so we prefer to take emerging market exposure via the EMBIGD Index, which has an attractive 310bps spread over Treasuries, and is more regionally balanced (with less than 20% weight in Asia, and just 4% in China).


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