Global Asset Allocation: May Viewpoints

1. Market Perspective 

• Slowing economic growth, lingering inflation and declining liquidity keep us cautious, while a still resilient labour market, solid consumer and corporate balance sheets and China reopening remain positives against otherwise negative sentiment.
• A widening gap in monetary policy is likely ahead as the Federal Reserve (Fed) is expected to pause after May and the Bank of Canada remains on hold, while the European Central Bank and Bank of England remain hawkish. Meanwhile, increased uncertainty around the Bank of Japan persists under new leadership as they evaluate yield curve control policy.
• Key risks to global markets include a sharp decline in growth, central bank missteps, persistent inflation, liquidity shock and geopolitical tensions.

2. Portfolio Positioning 

As of 30 April 2023

• We maintain a cautious stance with an underweight to equities and government bonds in favour of cash. Equities remain vulnerable to a slowing economy and weaker earnings backdrop, while central banks’ bias, albeit moderating, toward inflation fighting remains a potential headwind to bonds. Cash offers liquidity in an uncertain environment and still attractive yields
• Within equities, we remain overweight areas of the market that offer attractive valuation support, including small-/mid-cap stocks, Japan and emerging markets.
• Within fixed income, we added to global high income given attractive yields and emerging market (EM) local currency bonds given appealing yields levels and relatively cheap EM currencies that may appreciate because of a weaker US dollar against narrowing growth and interest rate differentials as the Fed nears its anticipated terminal rate.d. 

3. Market Themes 

Looking for Direction 

While the market narrative is that a recession is inevitable, especially in the US, economic data continue to be mixed with seemingly sufficient evidence to support both bulls and bears outlooks for the markets. Bulls continue to lean on evidence of a still robust labour market, strong consumer and corporate balance sheets, a better-than-expected earnings season and signs of moderating inflation supporting a pause in central banks’ tightening. Meanwhile, bears cite lagging impacts of central bank tightening, regional banking turmoil, contractionary manufacturing data, still high inflation and a deeply inverted yield curve as top reasons why a deeper recession is coming. While we agree that the data remain mixed, the trend will likely continue to be negative into the back half of the year with employment softening and economic growth contracting. However, at this point, it is difficult to gauge the potential depth and duration of the contraction, leaving us broadly cautious as we keep an eye on data, looking for more direction.

Finding the Sweet Spot 

Despite slowing economic growth amid an aggressive tightening campaign by the Fed, the labour market has remained resilient, especially with the unemployment rate anchored near 3.5%, but some fissures appear to be forming. Looking below the surface, peaking wage growth, declining job openings and mixed continuing claims data are telling us that the employment picture may be finally softening. Headlines of recent layoffs also indicate labour market weakness, although most of them have been concentrated in the higher-earning technology and financials sectors, while the lower‑income and service-related job market remains tight. This is an unusual trend and a result of the lag in reopening from COVID, which has created a lack of supply in labour as services demand has returned. Despite this still positive undercurrent, we are expecting further softening in the labour market evidenced in our research of staffing companies seeing significant weakness in demand, usually an early sign of pending deterioration. This should be a welcome sign for the Fed as a softening labour market will surely ease wage pressures and ultimately help on the disinflation front.

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