Our preferences

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.

* We do not apply tactical preferences to non-traditional asset classes. Additionally, non-traditional assets are not be suitable for all investors.

 

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 sharp rebound in global equities at the beginning of the year has faded somewhat as valuations have re-rated and are now back close to their fair value. Further gains in equity markets would require macro momentum to accelerate and earnings to be upgraded, which has yet to happen. In our US multi-asset TAA, we close our overweight to US equities and introduce overweights to emerging market and Japanese stocks.

We are now neutral on US stocks. Economic growth is forecast to slow in 2019 as the positive effects of tax reform and fiscal stimulus fade. Earnings growth is likely to be about low-single-digits after advancing more than 20% in 2018. At a trailing P/E of 18.1x, US equities are relatively expensive, trading above both their 10-year and 20-year averages.

We recently removed our preference for value over growth stocks and now 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.

We recently removed our preference for value over growth stocks and now 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.

We have no relative preference across size segments and therefore have a benchmark allocation to large-, mid-, and small-caps. 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 have no relative preference across size segments and therefore have a benchmark allocation to large-, mid-, and small-caps. 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 are underweight Eurozone equities. Economic activity in the region has weakened. In March, manufacturing PMIs dropped to the lowest level since 2013, while services PMI continued to recover. This has led to the largest gap between the two prints since 2002. Solid services data, combined with improving China PMIs, should support Eurozone data in the months ahead and help turn around the recent negative trend. Eurozone equities, however, already appear to be priced for such a scenario, given that they have rallied 15% year-to-date. At the same time, external risks persist, as the US-China trade conflict and Brexit could weigh on sentiment.

We are neutral on UK equities, on a tactical time horizon. The UK valuation is attractive but uncertainties remain. We are underweight UK equities over a 1–4 year horizon. We see better long-term opportunities in EM dollar-denominated sovereign bonds.

We are taking Japanese equities to overweight as they have lagged other cyclical markets since the beginning of the year and should re-rate on the back of improving macro data. We have revised our earnings growth forecast for FY2019 (end-March 2020) to 3% y/y from 1% previously. We believe consensus earnings will continue to slow for some time but expect a recovery from 2H19. With valuations significantly below historical averages, we think some of Japan's quality companies are attractive.

We are taking Japanese equities to overweight as they have lagged other cyclical markets since the beginning of the year and should re-rate on the back of improving macro data. We have revised our earnings growth forecast for FY2019 (end-March 2020) to 3% y/y from 1% previously. We believe consensus earnings will continue to slow for some time but expect a recovery from 2H19. With valuations significantly below historical averages, we think some of Japan's quality companies are attractive.

We prefer these fallen angels as well as companies that stand to benefit from an increase in digital payments in Japan, and firms that have a solid ESG strategy.

Emerging market (EM) equities have rallied over the past month driven by positive developments in the US-China trade front and economic outlook mostly driven by China’s economic green shoots. MSCI EM has surpassed our last six-month target (1,080) and the new six-month target is 1,160. However, an observable sustainable recovery across the EM universe in the next few months is needed to offset the downside idiosyncratic risks in Africa, Russia, Turkey, and Brazil. We see valuation, at 13.3x the 12-month-trailing P/E, as fair to their developed market counterparts at 16.5x P/E. The aggregate EM manufacturing PMI improved to 50.9 from 50.5 in the last month, mainly due to better data in China and Russia.

Bonds

A sharp recovery in 10-year Treasury yields from the low of 2.32% toward the end of March was witnessed during the last week of the first quarter. Stronger China growth numbers, oversold positions, and mitigating trade tensions have pushed the 10-year yield to 2.60% during the first few weeks of April. We anticipate a gradual rise in interest rates into the second quarter as GDP continues to improve.

We maintain our overweight to long-duration Treasuries versus cash. While it‘s becoming clearer that US and global growth are accelerating, a significant rise in rates is unlikely. US inflation continues to fall and the core PCE index, the Fed‘s preferred inflation gauge, is unlikely to reach 2% before year-end. Consequently, we don‘t expect the Fed to raise rates until at least early 2020. Meanwhile, the cyclical uptick in growth may prove fleeting. An overweight to long-duration Treasuries provides some portfolio protection against equity volatility and a resurgence of recession fears.

Over the past month, municipal bond mutual funds continued to report net cash inflows, reflecting strong demand from individual investors. Year-to-date, muni funds have now attracted USD 27.8bn in new assets according to the Investment Company Institute (ICI). Tax-exempt has posted a 2.8% total return thus far in 2019. By comparison, US Treasury securities registered softer results (+1.2%). Finding attractive values in the muni market has become more challenging. Credit spreads are tight.

Investment-grade corporate bonds had a very strong start into 2019, with excess returns relative to Treasuries of 3.5%. Current spreads of 116 basis points (bps) fall below our 120bps to 140bps target range for the next six months. However, against a backdrop of persistently dovish central banks and our outlook for an economic stabilization in 2H19, corporate bonds should remain supported. But from current levels, spreads are unlikely to tighten much further, while duration risk becomes more prominent, keeping us tactically neutral.

Credit spreads on HY bonds tightened slightly over the past month, helping to lift high yield‘s total return to 8.7% year-to-date. Gradually tighter financial conditions and more aggressive corporate behavior as the cycle matures should push credit spreads wider, in our view. That said, the US economy should only slow to trend growth and issuer fundamentals aren‘t flashing red. While current spreads of 364bps look tight, we believe the Fed‘s more cautious stance and progress on trade have potential to sustain spreads in the short term.

Over the past month, interest rates across developed markets have been mixed, with slightly lower yields in most of the Eurozone and slightly higher yields in some other countries. On foreign exchange markets, the dollar was overall modestly higher against other major currencies. The net result was a near-zero return over the month. Non-US developed bond yields are mostly at very unattractive levels. We do not recommend a strategic asset allocation position on the asset class.

EM credit delivered mid-single-digit gains year-to-date on tighter spreads and lower UST yields. The asset class benefited from a more dovish Fed, progress in US-China trade talks, additional Chinese stimulus, and rising oil prices, among other factors. Our six-month base case calls for sideways sovereign spreads and slightly wider corporate spreads. Key risks include a sharper-than-expected global slowdown, tighter USD liquidity, and renewed tensions between the US and China. We remain overweight EM sovereign credit and hold a neutral position in EM corporate credit in globally diversified portfolios.

We overweight EM dollar-denominated sovereign debt vs. US government bonds. Emerging market US dollar-denominated sovereign bonds have a more favorable longer-term risk-return outlook, with spreads of 341bps over US Treasuries. They‘re supported by the Fed likely being on hold for 2019 and acceleration in China‘s growth. Additional spread compression may be limited, but in a benign environment they provide attractive addition yield, especially with US rates unlikely to rise very much in the next two quarters.


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