Global Asset Allocation: The View From Europe

1. Market Perspective

• Global growth is showing increasing signs of cooling along with easing inflationary pressures.
• Recent data across labour markets, consumers and businesses are pointing toward moderating US growth. European growth is supported by services, while manufacturing lags. Japanese growth is expected to rebound from a contraction earlier in the year. China extends stimulus measures to support housing and to the consumer to stabilise growth. 
• There are growing concerns that the Fed may be behind on rate cutting amid more evidence of slowing growth. The European Central Bank (ECB) maintains a dovish stance, with further cuts expected. The Bank of Japan (BoJ) rattled markets with a surprise rate hike, despite soft economic growth. The Bank of England (BoE) has cut despite services and wage inflation remaining above levels of 5%.
• Key risks to global markets include a steeper decline in growth, central bank policy missteps, the election calendar, geopolitical tensions and the trajectory of Chinese growth.

2. Portfolio Positioning

As of 31 July 2024

• We remain modestly overweight equities with the recent pullback broadly improving valuations. While markets remain concentrated, valuations beyond narrow leadership are reasonable with earnings growth supportive.
• We maintain an overweight to cash relative to bonds. Cash yields still remain attractive and they provide liquidity should market opportunities arise.
• Within equities, we remain overweight value based on more attractive relative valuations. Value is likely to benefit from easing monetary policy, while growth faces the hurdle of higher expectations.
• Within fixed income, we continue to favor higher‑yielding sectors—including high yield and emerging markets bonds—as fundamentals remain broadly supportive.

3. Market Themes

You’re Killing Me, Smalls

Going into the recent Fed meeting, anticipation for the bank to signal that it was nearing the start of rate cuts led small‑caps to outperform larger counterparts by 10% for the month. Unfortunately for those small‑cap investors, who have long been waiting for a recovery in a space held captive by higher‑for‑longer rates, those gains were quickly killed. The next day’s weak jobs report and the untimely move by the BoJ reversed the market narrative around impending rate cuts being supportive for small‑caps to instead reflect that it is too late to help an already weakening US economy. The worse‑than‑expected jobs number follows other recent data suggesting weakness in manufacturing and consumer finances. The view that small‑caps’ vulnerability to higher interest rates would now be allayed amid lower rates has been overwhelmed by concerns about their economic sensitivity, which the market now seems to be prioritising. With the prospects of a soft landing now in question, it’s less likely that interest rate cuts alone will be sufficient to fuel small‑cap outperformance until we see clear evidence that growth is going to be stabilised.

Getting Carried Away

The unfortunate timing of the BoJ’s surprise interest rate hike last week, colliding with the Fed’s decision to delay the start of cutting rates the day before disappointing US labour market data were released, sent global risk assets plummeting. Japanese equities were among the hardest hit after having been the darlings of the developed markets since last year on improving investor sentiment and reflation hopes. The sharp move lower in Japanese equities was exacerbated by the dramatic move higher in the yen as investors scrambled to get out of carry trades where they were short the lower‑yielding yen and long other higher‑yielding currencies. The yen carry trade has been a longtime favourite and crowded trade where significant leverage can be deployed, making today’s unwind concerning as investors could be taking substantial losses as they are forced to buy back yen at much higher levels. This unfortunately comes at a time when the market narrative for US growth has changed just as quickly with fears that the Fed may be behind the curve, and it likely has made the Fed and BoJ’s jobs a lot harder than they already were.

 

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