Asset Allocation Viewpoints: April Insights

1. Market Perspective 

• Lagged impacts of central banks’ tightening are to weigh on growth and the earnings outlook in the back half of the year, with expectations of lower inflation but still above central bank targets. 
• The recent banking crisis and unexpected oil supply cuts complicate inflation and the financial stability puzzle for central banks and could keep interest rate volatility elevated. 
• While consensus builds for a slower growth outlook, China reopening and resilient growth in Europe offer balance to an otherwise negative sentiment.  
• Key risks to global markets include central bank missteps, resilient inflation, steeper growth decline, a broadening banking crisis and geopolitical tensions.

2. Portfolio Positioning 

As of 31 March 2023 

• We remain underweight equities and fixed income in favour of cash. Equities are vulnerable to the weaker growth and earnings backdrop, and still aggressive central banks could weigh on fixed income as they continue to battle inflation, while cash continues to offer safety and attractive yields. 
  
• Within equities, we remain overweight to areas with more attractive valuation support, including small-/mid-caps, global ex-US and emerging markets. 
  
• Within fixed income, we are underweight European government bonds but added to inflation-linked bonds. While rate volatility is to remain elevated, rates are likely to move higher from current levels. Nevertheless, duration offers ballast within our multi‑asset portfolios amid a potentially choppy back half of the year and inflation-linked bonds offer some protection should inflation prove more persistent than expected. 
  
• We have a positive view of the euro versus the US dollar. The interest rate differential between the European Union (EU) and the US is likely to narrow. The relative economic momentum of the US versus the EU may narrow because the EU has avoided a recession for now..
  

3. Market Themes 

It’s Complicated 

In light of the recent banking crisis, global central banks’ narrow focus on combating inflation has gotten more complicated as they now face the added task of maintaining financial stability. In an effort to thread the needle in reinstating price stability while shoring up confidence in the banking system, the US Fed announced a 25bps increase at its March meeting—an apparent compromise between a 50bps hike and no move at all—while at the same time swiftly launching a new emergency lending facility, the Bank Term Funding Program. This move is not unlike the Bank of England’s hurried rescue of the gilts market in October while still pursuing a tighter monetary policy. While rescue measures have seemed to quell a broader contagion for now, the immediate impact may be a further tightening of credit within the banking industry, which was already occurring prior to the crisis. This added dimension has only made central banks’ mandates more complex, given the already limited visibility into the lagged impacts of their own tightening measures. 

Finding the Sweet Spot 

With consensus calling for an economic slowdown in the back half of the year as tighter financial conditions take hold, it is increasingly challenging to find areas of optimism amid the impending gloom. However, emerging markets are one area that has done well recently—up over 17% off October’s bottom—that could continue to benefit from a lessening of headwinds. The recent outperformance was largely triggered by China’s surprise reopening from COVID lockdowns last fall, and while some of the euphoria has faded, recent data continue to show momentum and China policymakers are committed to stable growth, potentially providing a further boost. And while global growth is expected to slow, this should come with an easing of inflation pressures, lower rates and further weakening of the US dollar, all of which could be supportive for emerging markets. So unless global growth surprises significantly to the downside, emerging markets could find themselves in a sweet spot as we enter a period of slower, but not ‘off the rails’ growth. 

For a region-by-region overview, see the full report (PDF).