Tactical asset allocation - June 2024

The global recovery moves along. Overweight equities, credit, cyclical factors, and non-US equities.

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 reduced expectations of monetary policy easing in 2024 and the prospect of a “higher for longer” interest rate environment, risk assets continue to reflect optimism and confidence toward a favorable macro environment with muted volatility in the near term. Based on our framework, we expect global growth to remain below its long-term trend, but to potentially see a more balanced contribution from other parts of the world. While the United States has led the global recovery since late 2022, recent economic data point to a broadening out of growth momentum to other developed markets and emerging markets, except for China. 

Leading economic indicators continue to improve at a rapid clip in the eurozone, UK, and Japan, led by rising consumer confidence and manufacturing business surveys. Improving orders and demand expectations, particularly in export-oriented industries, are lifting the prospect for a cyclical rebound in Europe after a prolonged period of anemic growth (Figures 1a-c and 2). Similarly, global earnings revisions have started to reflect improving economic prospects outside the US, with a modest but encouraging upturn across developed markets and emerging markets, apart from China, while US earnings prospects continue to lead (Figure 3). In some respect, the relative performance between major equity markets has started discounting the potential for this rotation. After the pronounced leadership of US equities in January of this year, developed ex-US and emerging market equities have performed remarkably in line with US equities, despite the extraordinary outperformance of mega-cap US technology names.

China continues to lag. Stability in the manufacturing sector is more than offset by the housing downturn and weak domestic demand. Monetary policy support has been somewhat limited, constrained by considerations around FX stability due to capital outflow pressures, among other factors. However, a recently announced package of housing policy relaxation includes steps to support housing demand with lower down payment requirements and lower mortgage rates, as well as relending facility from the PBOC to support the purchase of unsold homes and reduction of housing inventories. These policies provide a step in the right direction to contain downside risks, but it is unclear how much additional policy support will be needed to support a turnaround in the housing market. 

Overall, our macro framework confirms a favorable outlook with low but stable global growth and rising risk appetite, a backdrop that has historically compensated investors for risk taking.

Investment positioning 

There are minimal changes in portfolio positioning this month. We overweight risk relative to the benchmark in the Global Tactical Allocation Model, overweighting equities over fixed income, favoring non-US equities, cyclical sectors, value, and smaller capitalizations, and remain underweight the US dollar. In fixed income, we maintain an overweight to credit risk2 via lower quality sectors, maintaining a neutral duration posture, favoring TIPS over nominal bonds, albeit with reduced exposure compared to last month (Figures 5 to 8). 

In particular:

• In equities, we overweight value, mid and small caps at the expense of quality, low volatility, and momentum factors. Growth is stable, just below its long-term trend, while global risk appetite continues to improve, signaling improving growth expectations. This backdrop has historically favored cyclical factors with high operating leverage and a higher sensitivity to a rebound in growth expectations, such as value and smaller capitalizations. Furthermore, we continue to see early signs of broadening equity market participation, with recent performance convergence between styles/factors and regions. Similarly, we favor exposures to cyclical sectors such as financials, industrials, materials, and energy at the expense of health care, staples, utilities, and technology. From a regional perspective, we overweight emerging markets and developed ex-US equities, supported by improving risk appetite, expectations for US dollar depreciation, and improving leading indicators in European growth. 
• In fixed income, we overweight credit risk via high yield, bank loans, and emerging markets hard currency debt. Credit spreads continue to gradually tighten with subdued volatility, offering a stable yield advantage over government bonds in a supportive macro backdrop with rising risk appetite and reach for yield. In sovereigns, we favor inflation-protected securities (TIPS) in the US, but with reduced exposure, while we moved back into nominal bonds in Europe, given the recent deceleration in inflation (Figure 4).
• In currency markets, we underweight the US dollar, as regimes of cyclical recoveries are typically accompanied by strong reflationary flows into non-US assets. 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, the Japanese yen, the Australian dollar, and the Canadian dollar. In EM, we favor high yielders with attractive valuations, such as the Colombian peso, the Brazilian real, the South African rand, and the Indonesian rupiah relative to low yielding and more expensive currencies, such as the Korean won, the Mexican peso, the Philippines peso, and the Chinese renminbi, but still expect these currencies to do well in a the US dollar depreciation scenario.

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.