Tactical Asset Allocation - January 2025

Maintain defensive portfolio positioning. Overweight fixed income versus 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

Market trades associated with the US election have begun to lose momentum and unwind earlier gains. US small and mid caps have given back all the outperformance over US large caps since election day, and over the past month, emerging market equities have outperformed US equities despite unremarkable economic performance and concerns around global trade policy. As we highlighted last month, these developments are reminiscent of the same pattern that followed the 2016 election, with markets focusing on newer and potentially more consequential developments. 

The December FOMC meeting provided a noticeable break in the prevailing expectation for a long and gradual easing cycle. After delivering 100 basis points (bps) in rate cuts over the last three meetings, the FOMC effectively delivered a U-turn on its economic forecasts and expected policy path compared to Powell’s Jackson Hole speech in August and the September FOMC meeting. Headline and core inflation statistics are no longer decelerating at the rapid pace experienced in 2023 and the first half of 2024. This, coupled with higher inflation uncertainty due to increased ambiguity regarding tariffs, global trade and immigration policies, has caused the Federal Reserve’s inflation projections to “kind of fall apart,” as described by Chair Powell. The FOMC made clear that any adjustments to policy rates will hinge on further progress in cooling price increases, expecting to deliver only two additional rate cuts in 2025 compared to earlier projections for four rate cuts. Equity and bond markets reacted negatively. This heightened inflation data dependence is a significant shift in strategy compared to the communication at Jackson Hole in August, where Powell stressed the increased confidence of the FOMC that inflation was on a sustainable path back to 2% while highlighting the urgency to focus on a weakening labor market. Following this backdrop, the sensitivity of equity and bond markets to economic data, both growth and inflation, is likely to increase meaningfully in 2025, potentially seeing the return of cyclical macro indicators as primary drivers of market performance. 

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&2). 

Investment positioning 

There are no changes in portfolio positioning this month. We underweight risk relative to benchmark in the Global Tactical Allocation Model,¹ underweighting equities relative to fixed income, favoring US equities and defensive sectors with quality and low volatility characteristics. In fixed income, we underweight credit risk² 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 versus nominal bonds  (Figure 3).
• 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, Norwegian kroner, Swedish krona, and 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, Philippine 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.