Global Asset Allocation: April Insights

1. Market Perspective

• The rollout of vaccines is likely to lead to easing lockdowns, continued economic recovery and release of pent-up demand. However, the recovery may be uneven and choppy because of concerns about virus variants, the economy overheating, rising inflation—particularly in the US—and elevated valuations of most risk assets.
• Monetary policy is likely to remain supportive, as is fiscal stimulus. These two combined should help provide a bridge between lockdowns and economic reopening.
• Inflationary pressures as well as more positive views on the economic recovery are leading to higher government bond yields.

2. Portfolio Positioning

• We shifted to a modest underweight to equities relative to bonds and cash as the risk/reward profile of equities looks less attractive after a strong multiple-driven rebound since last March’s lows.
• As we sell stocks, we continue to lean into value versus growth. The valuation case for small‑caps is not as strong as for value. Hence, we reduced the small-cap exposure.
• The British pound is at an attractive valuation relative to the euro. The vaccine rollout in the UK is progressing quicker than in the EU. This should support a stronger British pound, but the path is likely to be bumpy.

3. Market Themes

Closing the Gap

As investors grew more optimistic late last year about the global economic recovery, small-cap stocks took off with a parabolic snapback, up over 100% since the lows of last March. While smaller companies tend to lead early in an economic recovery given their higher sensitivity to growth, the fast and furious pace of performance stands out. Meanwhile, cyclically oriented value stocks, which are also highly reliant on the trajectory of economic growth, have just begun to make up ground from the sell-off. While smaller companies may continue to benefit from reopening and stimulus in the US, a lot of the outperformance may be behind small-caps, while value stocks are likely to continue to benefit from the recovery, stimulus, higher rates and the potential for infrastructure spending. After nearly a decade of underperformance, perhaps this cyclical rally may be enough for value to close the gap versus growth stocks.

Reason to Worry?

Equity markets are riding higher on unwavering optimism, which has driven the S&P 500 up over 20% above its pre-COVID-19 levels. Despite higher valuations, bouts of risk and pockets of froth in the market—such as in bitcoin, home prices and special purpose acquisition companies—investors appear to have little concern. Perhaps there is no alternative to investing in equities with bond yields on the rise, but it’s hard to ignore events such as the retail investor GameStop short squeeze and enormous losses at Archegos Capital, a large private family office, which may have historically shaken the confidence of equity investors. While recent bad news is largely viewed as idiosyncratic, market valuations continue to get more extended, and the risk of one of these events sparking a more systemic sell-off could increase. But perhaps the systemic risk is already here, with the threat of even higher rates, inflation and now taxes.

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