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

The US threat of additional tariffs on Chinese imports has thrown the trade truce reached at the G20 summit in June into doubt, and global stocks are down 5% since the announcement on 1 August. While additional tariffs on some Chinese goods from 1 September now seems all but certain, ongoing negotiations between the US and China could still reduce tensions in the coming months. Meanwhile, further Fed rate cuts have become increasingly likely, which would be positive for risk assets. Given the increased tensions, we modestly reduced our overall equity risk this month.

We close our overweight to US equities. While US equities still look attractively valued relative to government bonds, uncertainty in the trade relationship between the US and China caps the upside for now. Although action by the Fed can minimize the downside, we are no longer confident that Fed easing will push stocks significantly higher. A shift in the outlook for trade talks, either toward further escalation or a truce or deal, could change this outlook rapidly.

We maintain benchmark allocations to both growth and value. We continue to recommend a neutral allocation across growth and value styles. The economic backdrop is supportive of growth firms, which usually outperform later in the business cycle, but their valuations are higher than long-term averages relative to value firms. We also remain neutral across size segments.

We maintain benchmark allocations to both growth and value. We continue to recommend a neutral allocation across growth and value styles. The economic backdrop is supportive of growth firms, which usually outperform later in the business cycle, but their valuations are higher than long-term averages relative to value firms. We also remain neutral across size segments.

We remain neutral across size segments. Relative valuations for small-caps and mid-caps versus large-caps remain near historic lows, but earnings growth has lagged for these smaller firms.

We remain neutral across size segments. Relative valuations for small-caps and mid-caps versus large-caps remain near historic lows, but earnings growth has lagged for these smaller firms. The slowdown in global economic growth is disproportionately impacting smaller companies, which tend to be more economically sensitive. Small-cap stocks have underperformed their large-cap counterparts by more than 5% this year.

Within international developed market stocks:

We are neutral on UK equities as concerns around the Brexit arrangement persist. A hard Brexit remains a tail risk, and high levels of volatility are likely to persist over the coming weeks. The long-term risk outlook for UK equities is uncertain, and we recommend investors reduce their exposure.

We are neutral on Swiss stocks. At a 12-month trailing P/E of 19x, they are the most expensive market in our coverage universe, trading at a 20% premium to global equities. However, dovish central banks and the decline in European rates have increased the appeal of defensive Swiss stocks as bond proxies.

We are neutral on Australian equities. Valuations do not look attractive, but they may still benefit from Chinese fiscal and monetary policies along with rising commodity prices. From a structural perspective, a slowing housing market is likely to limit banks' earnings growth.

We are neutral on Canadian equities. Current 12-month trailing P/E is below historical averages. Economic growth, however, is sluggish and consensus estimates on energy stocks' earnings growth could be revised down on the back of lower oil prices and pipeline capacity restrictions.

We are now neutral on Japanese stocks. The market looks attractively valued relative to history. Since the start of the year, Japanese stocks are flat, compared with a gain of over 15% for global equities. Consensus earnings continue to see downgrades, but earnings growth should stabilize in the second half.

We initiate an underweight to emerging market stocks, while reducing our underweight to international developed market equities. Emerging market firms are more exposed to heightened market volatility, a slowing global economy, and heightened trade tensions. Developed market equities are also exposed to these factors, but certain markets, including Japanese and Swiss equities, should perform relatively better in down markets. This brings our overall position in equities to underweight.

Bonds

The US 10-year Treasury yield reached its year-to-date low, touching 1.47% during the second week of August. Although this level was short lived and we continue to view 1.5% as a longer-term support in yields, potential concerns remain. These include trade tensions, Brexit, and emerging market (EM) performance. We have updated our interest rate forecasts and we look for the 10-year Treasury yield to trend higher toward 1.8% in the coming months.

We selectively close our overweight to long-duration US Treasuries versus cash. After their sharp decline we expect US Treasury yields to stabilize around current levels and gradually move higher, as the market is already pricing in more Fed rate cuts than we forecast. Long-duration Treasuries have been an effective hedge against equity market risk, but the position is less necessary after the equity allocation is trimmed. However, we continue to recommend these Treasuries for portfolios with high equity allocations.

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.

Munis have benefited from the strong rally seen in Treasury securities. AAA muni yields hit new lows. Year-to-date, tax-exempt paper has gained 7.8%, the strongest return seen since 2014. Technical factors have also played a role. Muni mutual funds have now attracted net new cash for 31 straight weeks. At the same time, the pace of new issue supply remains muted. 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 the asset class’s high duration makes it sensitive to changes in rates, the supply-demand picture is titled in IG’s favor. Demand should be supported by the preponderance of negative yields abroad. The gross amount of new IG supply has not overwhelmed this year and net issuance is historically low due to high bond redemptions. We 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.

HY has struggled this month along with the stock market volatility and the decline in oil prices. The energy component of HY has a month-to-date return of –3%. With energy representing the largest HY sector weight, this has weighed on overall performance, which is –0.2% on the month but up 10.5% this year. HY spreads have widened to 421bps, which is still about 100bps tighter since the beginning of the year. Defaults remain at historic lows and although the current spread is slightly above our target range of 380–420bps, we remain neutral on HY bonds.

Over the past month, bond yields have moved lower in non-US developed markets as disappointing economic data added to expectations that central banks will cut rates. On foreign exchange markets, the dollar was mixed, gaining against the euro but weakening versus the yen. This allowed the drop in yields to flow through into positive returns when measured in dollars. With yields falling to new lows, including negative yields on many bonds, non-US developed market fixed income is 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 Treasury yields. The asset class also benefited from dovish central banks and continued Chinese stimulus measures, despite a more uncertain global environment. Our six-month base case calls for tighter EM sovereign and corporate spreads. Global macro and geopolitical risks remain elevated, but dovish central banks appear as a supporting factor. We advise investors to hold a strategic allocation to EM credit in globally diversified portfolios.

We initiate an overweight in US-dollar-denominated emerging market sovereign bonds. The spreads on emerging market bonds have recently widened slightly above their five- and 10-year averages. With central banks easing, higher quality credit should remain supported as growth slows. Spreads may widen further if trade tensions continue to escalate, but that will be partly offset by Treasury rates likely falling.


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