Broadly speaking, we believe the world economy will continue to grow at above stall speed and see the cycle end as a relatively distant prospect. Here, we explain our current thinking behind our recommended tactical positioning. We still see investors being best served by leaning portfolios towards developed equities.
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We maintain a Strategic Asset Allocation for five risk profiles, based on our outlook for each of the asset classes. Our Tactical Allocation Committee (TAC), comprised of our senior investment strategists and portfolio managers, regularly assesses the need for tactical adjustments to those allocations, based on our shorter-term (three to six month) outlook. Here, we share our latest thinking on our key tactical tilts.
Developed Markets Equities: Overweight (changed 22 July 2016)
“Some returning inflation is central to our current tactical posture”
We retain our view that the still under-appreciated prospects for global growth and inflation will likely be the primary driver of investment returns on a six- to twelve-month view. It is these prospects that are likely to be most influential with regards to the performance of capital markets, rather than the ever-murky political backdrop.
On this, we still advise investors not to underestimate the US consumer, particularly with real disposable income growing at such a robust pace. This positive view on the prospects for the US economy and its stock market may surprise those again calling for US profit margins to continue rolling over. However, we see such forecasts as likely understating the negative effect of energy sector earnings over the last year as well as the headwind to profits from the previous ascent of the US dollar. Both of these factors should fall out of the data in coming quarters.
In the wake of the EU referendum, we have moved from a neutral to overweight tactical position in UK large cap equities within Developed Markets Equities with the move funded by increasing the underweight in Japanese equities. This move is primarily defensive, with the UK large cap index a potential net beneficiary from a deterioration in the UK economic backdrop. We have since added further to our tactical overweight in Continental European equities, looking to take advantage of excessively pessimistic expectations with regards to the European banking sector in particular.
Emerging Markets Equities: Neutral
We moved our recommended tactical position in Emerging Markets Equities up to neutral in January. We are looking for a more visible turn in earnings momentum before adopting a positive tactical posture. The bounce in China’s property market indicators, which now look to be in the process of peaking, has helped to stabilise sentiment towards the asset class. Meanwhile, a perhaps temporary reassessment of the pace of projected US interest rate rises has also been helpful.
Within Emerging Markets Equities, Asia remains our preferred region, with Korea, Taiwan and China (offshore) our highest conviction country bets on a strategic basis. The expected pick-up in global trade is central to this view. We continue to watch US and Chinese imports for any signs of this.
Cash & Short-Maturity Bonds: Neutral (decreased 22 July 2016)
Given ongoing market volatility, cash continues to play a pivotal portfolio insulation role. While the fixed income universe remains unattractive at current extreme valuations, cash offers a source of funds to invest into other asset classes when appropriate opportunities arise. Evidence of some returning inflation in the US obviously needs to be watched very carefully.
Developed Government Bonds: Neutral (decreased 22 July 2016)
With nominal yields offered by large chunks of the government bond universe negative or close to it, investors will likely have to work hard to make real returns from these levels over the next several years. Our view remains that such valuations underestimate the underlying inflationary pressures within the US economy in particular, something that incoming inflation data pay some testament to. While the level of (returns insensitive) central bank ownership suggests that the bond market may lag a pick-up in inflation, our continuing small strategic and tactical allocation to the area suggests that higher real returns lie elsewhere.
Investment Grade Bonds: Underweight
The spread of investment grade credit over government bond yields remains close to its ten-year average. However, this leaves nominal yields in high quality corporate credit low in absolute terms and may make the job of those trying to make positive real returns difficult.
High Yield & Emerging Markets Bonds: Overweight (increased 6 July 2016)
Earlier in the summer we moved from a tactical underweight to overweight position in High Yield and Emerging Markets Bonds by adding to Global High Yield. This was funded by moving from a tactical overweight to neutral position in Cash & Short-Maturity Bonds. Given our more sanguine take on the various risks to global growth and inflation, yields on junk credit look attractive on a risk-reward basis. Emerging Markets Bonds are expensive and remain vulnerable to a reversal of inflows during the slow process of monetary normalisation.
Commodities: Neutral (increased 13 May 2016)
We closed our long-held underweight in the commodity complex in May. US monetary normalisation will likely provide a headwind, but the bounce in China’s property market indicators looks sufficient to offset this for the moment.
Investors are likely best served by tilting their commodity exposure towards oil and away from gold where possible, with the latter still particularly vulnerable to further US interest rate rises. We see oil prices continuing to drift higher over the coming 12 - 18 months as the market’s worst fears on China fail to materialise and a smaller than suspected surplus is worked through.
Real Estate: Neutral
Recent volatility has served as a timely reminder of the importance of maintaining a diversified portfolio with the ability to weather a number of market environments, and we continue to encourage clients to ensure that they are fully allocated to Real Estate.
Alternative Trading Strategies: Underweight (decreased 13 May)
We shifted our previous tactical underweight in Commodities to Alternative Trading Strategies (ATS). This is primarily a function of the difference in volatilities for the two asset classes. There is less risk being underweight the lower volatility ATS in the current market environment in our opinion. Alongside this, regulation and lower leverage leave this diversifying asset class without much tactical appeal at the moment.