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.

 

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

Equities

Equity markets continued their recovery in July after the pause in May, as the G20 in Japan brought a trade truce between the US and China. We recommend a tactical overweight to equities, with a regionally selective approach to manage risks and harness opportunities.

We are overweight US equities relative to international developed market stocks. International developed market equities, Eurozone stocks in particular, are vulnerable in an environment of global trade uncertainty and weaker global growth. EMU manufacturing PMIs have been below 50 since February, showing no signs of improvement. However, Eurozone equities have fully participated in the global equity rebound year-to-date and are priced for a solid economic upswing, limiting the upside from here. In addition, the Eurozone faces significant political risks, such as Italian budget tensions, trade tariffs, and Brexit, which could reverse any improvement in sentiment. We expect the US market to be more resilient. The Fed has more ammunition than the ECB to combat slowing growth should trade tensions escalate.

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. While valuations for small-caps and mid-caps are more attractive, earnings growth is lagging. The slowdown in global economic growth is disproportionately impacting smaller companies, which tend to be more economically sensitive.

While valuations for small-caps and mid-caps are more attractive, earnings growth is lagging. The slowdown in global economic growth is disproportionately impacting smaller companies, which tend to be more economically sensitive. Small-caps have more domestic exposure and disproportionately benefited from tax reform in 2018. However, this boost has faded and small-cap earnings growth has meaningfully lagged that of large- and mid-caps as year-over-year comparisons weighed on results. This is expected to continue through 2Q19. Small-caps tend to outperform when high yield credit spreads narrow. With high yield credit spreads lower than average (after recent volatility), the scope for further narrowing appears limited, especially considering that we now believe we are in the late stage of the business cycle. Leverage in small- and mid-cap companies is above historical averages versus large-caps. This suggests that smaller-sized segments could be more vulnerable than normal if financial market volatility flares up.

Within international developed market stocks, we are tactically neutral UK equities. The long-term risk outlook for UK equities looks 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 16% 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 stocks. Current 12-month trailing P/E is below historical standards; however, economic growth is slowing and consensus estimates on energy stocks' earnings growth could be revised down on the back of lower oil prices.

We are overweight Japanese stocks. The market looks attractively valued. Since the start of the year, Japanese stocks are up just 8%, compared with over 18% for global equities. Consensus earnings continue to see downgrades, but earnings growth should stabilize in the second half.

We are overweight emerging market stocks. EM equities are primed to catch up to the rest of the world, having materially lagged year-to-date. Continued uncertainty around the global growth outlook will likely weigh on near-term sentiment, but assuming our risk case for global trade doesn't materialize, these equities offer an attractive potential upside. The region is trading at a 22% discount to developed market equities based on trailing P/E ratios, but volatility should stay high in the region until we have more clarity around trade negotiations.

Bonds

The US 10-year Treasury yield reached its year-to-date low of 1.93% on 5 July. This was short lived however, as non-farm payroll, retail sales, and the recent inflation indicators the consumer price index (CPI) and the producer price index (PPI) all came in above expectation. We continue to believe the bulk of the yield decline in treasuries is behind us. The incremental total return from owning treasuries remains limited given the yield declines in 2019.

We overweight long-duration US Treasuries versus cash. We continue to recommend an overweight to long-duration Treasuries as a hedge against equity market risk. While 30-year Treasury yields have already fallen over 40bps this year, they could fall at least that amount if growth continues to slow and the Fed cuts rates more aggressively.

After inflation expectations moved to their pre-presidential election low in June, we allocated to 5-year TIPS versus Treasuries and are now overweight the sector. With the Fed more dovish, inflation expectations should rise on the heels of a lower dollar, stable oil prices, increase in consumer spending, the impact from tariffs and a continued extension of the current expansion. Inflation expectations became too cheap given as a result of the multiple Fed tightening during 2018. We believe this will reverse over the next year, benefitting TIPS.

Munis are off to a good start for the second half of 2019. Month-to- date, munis are up 0.4%, boosting their year-to-date return to now sit at 5.8%. Municipal bond mutual funds have now attracted net new cash for 27 straight weeks. The high season for municipal bond maturities and reinvestment capital from bond calls has another month to go, representing an important tailwind for munis. Credit quality spreads remain narrow, suggesting that there is an opportunity to upgrade muni portfolios.

We remain neutral on IG. While the asset class’ high duration makes it sensitive to changes in rates, the supply/demand picture is tilted in IG’s favor. Demand should be supported by the large stock of negative yields abroad. The gross amount of new IG supply has not overwhelmed this year (down 10% year-over-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.

Credit spreads on HY bonds moved modestly tighter over the past month following a cooling of US and China trade tensions and dovish signaling by the Fed. In addition to spread contraction, HY total returns of 10% this year have also been supported by lower Treasury yields. With downside macro risks having diminished slightly and the default outlook benign, we reduce our HY spread forecast range to 380 basis points (bps) to 410bps. Current spread levels sit in the middle to this range. We believe the Fed’s more cautious stance and investor appetite for yield should be supportive for spreads in the short term.

Over the past month, bond yields have generally moved lower in non-US developed markets on speculation that more central banks will cut rates. On foreign exchange markets, the dollar strengthened modestly against most other major currencies, hurting returns when measured in dollars. Overall, returns were still in positive territory for the month. With yields falling to new lows, including negative yields on many bonds, non-US developed fixed income is unattractive. We do not recommend a strategic asset allocation position on the asset class.

EM corporate and sovereign credit have delivered high single- and low-double-digit gains year-to-date, respectively on tighter spreads and lower UST yields. The asset class also benefited from the US-China trade cease fire, continued Chinese stimulus measures, and higher oil prices, among others. Our six-month base case calls for range-bound EM sovereign spreads, and somewhat wider corporate spreads. Global macro and political risks remain elevated, but dovish central banks and favorable commodity pricing conditions appear as supporting factors. We advise investors to hold a strategic allocation to EM credit in globally diversified portfolios.

We remain neutral on emerging market dollar-denominated sovereign debt.


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