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

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 and cyclically exposed developed markets, with earnings being affected directly via tariffs and indirectly via slowing economic activity. Given the uncertainty around the trade dispute, we maintain our underweight positions in emerging market and international developed market equities.

We are neutral US equities but prefer it to other regions based on superior US earnings growth. 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. In our base case, trade frictions between the US and China will continue to increase, which could be a source of continued market volatility. However, we don't expect the dispute to escalate to the point that it sends the US into a recession. 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.

We keep our underweight to international developed market equities, particularly to Eurozone equities. We believe Eurozone stocks are vulnerable in an environment of heightened trade uncertainty and weak global growth. EMU manufacturing PMIs have been below 50 since February, showing no signs of improvement. Beyond exposure to ongoing trade tensions and weak manufacturing growth, the ECB has limited room to cut interest rates to combat financial market and economic weakness.

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, thus limiting downside risks and providing rerating potential if global data were to improve from here. Even considering the recent downgrade to our earnings growth forecasts for FY2019 to –4%, from –2%, due to an escalation of trade tensions and yen appreciation, valuations continue to look attractive, especially when compared to other developed market stocks, particularly Eurozone equities. We expect an earnings recovery in the December quarter, largely due to base effects. We recommend that investors unhedge their Japanese equity exposure as yen strength benefits the position. Within Japan, quality companies are attractive. We like fallen angels, companies with high and stable dividends, and companies that have a solid ESG strategy.

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 first two weeks of September saw the 10-year Treasury yield jump amid renewed optimism over US-China trade talks. The move was exaggerated as some long positions were neutralized. The Federal Reserve cut rates by 25bps at its meeting on 18 September, citing global developments and their effects on the economy as the main driver of additional stimulus. We are expecting further cuts over the next few quarters in response to economic weakness. Within US government bonds, we continue to recommend an overweight to Treasury Inflation-Protected Securities (TIPS) versus nominal bonds, as markets are too pessimistically pricing future inflation expectations. TIPS would benefit should inflation expectations rise, as we expect.

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

Although the consumer price index (CPI) has been above expectations for two consecutive months, with core CPI recently coming in at 2.2%, TIPS performance have been struggling versus US Treasuries amidst the recent uptick in volatility. Given the decline in real yields, TIPS have still performed well on an outright basis, but they have not managed to keep up with Treasuries the past month. With an 8.8% year-to-date total return versus 8.5% in Treasuries, we maintain our TIPS overweight.

Muni yields bottomed out toward the end of August before reversing course in the early part of September. Volatility returned to the US fixed income markets just as the Labor Day holiday signaled the end of summer. Despite recent gains, month-to-date through 24 September, munis are down 0.7%, marking the first monthly negative return from tax-exempt paper seen in almost a year. Year-to-date, munis (+7.1%) are now lagging the better results posted by US Treasury securities (+8.1%). Lipper has reported 37 consecutive weeks of net cash inflows to municipal bond mutual funds. Year-to-date, inflows to muni funds now total USD 66.8bn. These are the strongest inflows seen in a few decades. We continue to favor investment grade munis rather than lower-rated high yield bonds based on tight credit quality spreads.

US investment grade (IG) corporate bond spreads have reversed course since their peak in mid-August and have tightened back toward their 2019 lows on tentative signs of constructive US-China trade talks and stabilizing economic data. US IG spreads have been trading in a relatively tight 20bps range since 1Q19, driven mainly by political developments. The Federal Reserve cut its policy rate again in September. Demand for bonds with carry remains high, allowing issuers to be very active. September saw one of the highest amounts of newly issued US IG bonds on record. As long as a recession is avoided, this is a decent backdrop for carry assets. US IG spreads are in the middle of our forecast range. 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.

HY credit spreads fully retraced their move wider in the first half of August, following signs of improving Sino-US trade talks and better-than-expected US economic data. Higher US Treasury yields offset part of that move, but total returns are still 0.5% month-to-date. Dovish central banks are putting downward pressure on benchmark yields and forcing investors to move into riskier asset classes. We expect the credit risk premium, the compensation on top of default losses, to remain below its post-crisis median as investors reach for yield in HY bonds. We believe spreads will move sideways to slightly wider over the next six months. We think they are unlikely to revisit their post crisis lows, given that uncertainty around global trade remains and we expect the US economy to slow down next year. The 12-month-trailing issuer-weighted default rate picked up slightly to 2.6% in August. We expect it to increase gradually to around 3% over the next 12 months.

Over the past month, bond yields have moved mostly higher in non-US developed markets, rebounding from previous declines. On foreign exchange markets, the dollar overall gained against other major currencies. These factors combined to cause negative returns when measured in dollars. 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 low double digit gains year-to-date on slightly tighter spreads and significantly lower UST 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 EM USD-denominated sovereign bonds as we think the current macroeconomic environment favors carry strategies.

In an environment of slower growth, central banks will continue to ease policy. We still see opportunities for investors to earn yield in US dollar-denominated EM sovereign bonds.


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