Tactical Asset Allocation - December 2024

Maintain defensive portfolio positioning. Overweight fixed income vs. equities, favoring US equities over developed ex-US and emerging markets, defensive equity factors, higher duration, and credit quality.  

Our macro process drives tactical asset allocation decisions over a time horizon between six months and three years, on average, seeking to harvest relative value and return opportunities between asset classes (e.g., equity, credit, government bonds, and alternatives), regions, factors, and risk premia.

Macro update

Despite positive sentiment towards US growth prospects following the US election, uncertainty surrounding global trade policies continues to exert a drag on global markets and, as a result, on market sentiment outside the US. Our barometer of global risk appetite has modestly improved over the past month but is yet to flag a sufficient rebound and inflection point in the cycle. However, global growth remains broadly stable around the world. Our macro framework remains in a contraction regime, signaling growth below-trend and decelerating growth expectations (Figures 1 and 2). On a positive note, following the heightened volatility in Chinese equity markets between September and November, in response to highly anticipated monetary and fiscal policy announcements, our China leading indicators have stabilized, showing improvements across manufacturing surveys, housing and construction indicators, industrial production and monetary policy conditions. As indicated in our recent commentaries, we continue to monitor developments in China and Asia more broadly, looking for early signs of a cyclical rebound in earnings expectations relative to developed markets, which are yet to materialize. 

Reflecting on markets post US election: Lessons from 2016-2017

The outcome of the US election has been the dominant driver of financial markets over the past month, with two main themes being priced across asset classes, namely a positive US growth shock with expectations of expansionary fiscal policies and a negative growth shock for the rest of the world with expectations for higher tariffs and global trade policy uncertainty. During the campaign, President Elect Trump suggested tariffs up to 60% on imports from China, and 10-20% on goods coming from elsewhere. As recently as last week, the incoming administration threatened 25% tariffs on imports from Mexico and Canada to be announced as early as the first day in office. Global equity and currency markets swiftly priced in the negative headlines.¹ While the outcome of the US election may seemingly represent a sudden change to the market cycle, with clear implications for asset prices over the coming quarters due to the medium-term nature of economic policies, we are skeptical of this interpretation and look at the experience from 2016 to draw valuable lessons. Following the Trump election in 2016, the same two policies emerged as primary drivers of markets in the immediate aftermath of the vote (US fiscal expansion and import tariffs). In fact, in the first month following the results, the relative performance across major asset classes back then was nearly identical to the performance we have experienced today, with US small caps outperforming US large caps, US equities outperforming non-US equities and emerging markets being the laggard (Figure 3a). However, over the course of 2017, markets experienced a nearly perfect reversal in this relative performance, with US small caps underperforming US large caps, US equities underperforming developed ex-US and emerging market equities, with the latter being the best-performing asset class. Similarly, US Treasuries also stabilized after the initial sell-off, posting small positive returns in 2017 despite fears of larger deficits and higher tariffs (Figure 3b). What happened? Did those policies fail to materialize? No. Fiscal expansion and global trade uncertainty were very prominent features of the following years, but so were several new developments. In particular, the global economy experienced what became the strongest “global synchronized recovery” since 2010, led by China, Europe, and a global inventory cycle restocking.²

To be clear, we have no preconceived expectation that markets in 2025 will follow the same patterns we observed in 2017. Instead, we highlight how this historical analogy provides a valuable reminder that markets promptly absorb new information, and even multi-year economic policies can be priced in —in a few weeks. Markets eventually return to focusing on incoming information and traditional drivers of performance such as monetary policy, the growth cycle, and inflation. Hence, we reiterate the importance of adhering to a disciplined investment process, processing incoming economic and financial data to drive asset allocation decisions, and refraining from extrapolating highly uncertain short-term developments into long-term trends. 

Investment positioning 

There are no changes in portfolio positioning this month. We underweight risk relative to benchmark in the Global Tactical Allocation Model,³ underweighting equities relative to fixed income, favoring US equities and defensive sectors with quality and low volatility characteristics. In fixed income, we underweight credit risk⁴ relative to benchmark and overweight duration via investment grade credit and sovereign fixed income at the expense of lower quality credit sectors. (Figures 4 to 7). In particular:

• In equities, we overweight defensive sectors with quality and low volatility characteristics, tilting towards larger capitalizations at the expense of value, mid and small caps. Despite the extended positioning in mega-cap quality names, we expect a combination of quality and low volatility characteristics to outperform and provide downside risk mitigation in a scenario of falling growth expectations, falling bond yields, and weaker equity markets. Hence, we favor exposures to defensive sectors such as health care, staples, utilities, and technology at the expense of cyclical sectors such as financials, industrials, materials, and energy. From a regional perspective, we maintain an overweight position in US equities relative to other developed markets and emerging markets, driven by declining global risk appetite, stronger US earnings revisions vs. the rest of the world, and a still favorable outlook for the US dollar.

• In fixed income, we underweight credit risk and overweight duration, favoring investment grade and sovereign fixed income relative to high yield. Credit spreads tightened further over the past month, clearly signaling resilience in credit markets. While the current backdrop does not suggest a major risk for credit spreads, downward revisions to growth expectations are likely to be accompanied by marginally wider spreads from cycle lows and lower bond yields, favoring higher quality and higher duration assets. In sovereigns, we maintain a modest overweight in inflation-protected securities vs. nominal bonds (Figure 4).

• In currency markets, we maintain a moderate overweight in the US dollar, as yield differentials with major foreign currencies are narrowing. However, overall higher yields and negative surprises in global growth still inform our position in favor of the greenback. Within developed markets, we favor the euro, the British pound, the Norwegian kroner, the Swedish krona, and the Singapore dollar relative to the Swiss franc, Japanese yen, Australian and Canadian dollars. In EM, we favor high yielders with attractive valuations, such as the Colombian peso, Brazilian real, Indian rupee, Indonesian rupiah, and Mexican peso, relative to low yielding and more expensive currencies, such as the Korean won, Taiwan dollar, Philippines peso, and Chinese renminbi.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations), and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value. Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.