Global Asset Allocation: The View From Europe

1. Market Perspective

• Constructive near‑term outlook on global economic growth against a backdrop of gradually easing inflationary pressures across most economies.
• US growth remains the most resilient amongst developed economies, while European and Japanese growth teeter near recession. The outlook for many emerging markets’ economies is improving, supported by easing inflation and lower rates, with signs that policy support is helping stabilise growth in China, although risks remain.
• The US Fed is looking towards rate cuts this summer, but sticky inflation and resiliency in the economy have tempered expectations for an aggressive start to the cutting cycle. The European Central Bank (ECB) appears closer to easing amidst fragile growth and continued progress with inflation. The Bank of Japan (BoJ) took its first step in unwinding ultra‑easy monetary policy, although the path remains uncertain.
• Key risks to global markets include a retrenchment in growth, stubborn inflation, volatility surrounding central banks’ policy divergence, geopolitical tensions and the trajectory of Chinese growth.

2. Portfolio Positioning

As of 31 March 2024

• We remain overweight equities, supported by firming growth and moderating inflation, positive earnings trends and reasonable valuations outside of large‑cap growth.
• We shifted to a neutral position in US small‑caps, balancing valuation considerations against the likelihood that interest rates remain higher for longer, weighing more on smaller companies.
• We shifted to neutral cash. While cash continues to provide attractive yields with the yield curve remaining inverted, we shifted to overweight inflation‑linked bonds to add some duration and inflation protection should inflation settle higher.
• We shifted to neutral euro versus the US dollar. The ECB may cut interest rates before the Fed does, increasing the interest rate differential between the two currencies and weighing on the euro. 

3. Market Themes

Gimme Some Credit!

Since the 2008 financial crisis, private credit markets have grown to nearly USD 1.7 trillion and are expected to double over the next five years, as investors continue to recognise the potential benefits from diversification and enhanced income offered by the asset class. Recent interest has not just been driven by investors, but by borrowers seeking flexible financing arrangements amidst a backdrop of rising rates and fewer options as banks have stepped back from lending. This retreat by banks has been due to a confluence of factors, including recent losses, exposure to commercial real estate, tightening regulations and de‑risking following the 2023 regional bank failures. Private credit firms were able to fill the void in lending, expanding their market share and moving up in deal sizes. With the higher‑for‑longer rate environment persisting, many existing borrowers are feeling the stresses, notably those with floating rate obligations or those needing to refinance. Private credit firms’ expertise in lending across different quality and types of companies, including distressed and commercial real estate, could prove beneficial as these areas could see increasing opportunities in the near term.

Back in the Money?

US equity markets are trading close to record levels fuelled by a 10%+ gain in the first quarter. While the equity rally began with the ‘Magnificent Seven’ stocks and euphoria around artificial intelligence companies, markets are starting to broaden out. Worries about the Fed delaying the start of interest rate cuts following recent rounds of disappointingly sticky inflation data haven’t slowed the momentum. Rather, equity investors have chosen to focus on the positives, including better‑than‑expected economic growth, a broadly resilient job market and rising earnings estimates. Perhaps the biggest positive of all is signs that the ‘Fed put’ may soon be back in the money, after having been abandoned as the Fed focused solely on fighting inflation, no matter the downside risks. Now, despite inflation still above target, Chairman Jerome Powell seems pretty intent on getting started on rate cuts this year. Perhaps the motivation is to get ahead of the elections or a worry that the lagged effects of tightening will finally start to crack the labour market. Whatever the reason, for now, equity investors seem to have yet another reason to rally, believing the Fed may be back to help mitigate downside risk.

 

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