Global Asset Allocation: February Viewpoints

1. Market Perspective

• While evidence of slowing inflation and moderating central bank tightening have reduced the probability of a hard economic landing, global growth is still expected to slow as tighter financial conditions flow through the global economy.
• The US Federal Reserve struck a dovish tone as they acknowledged that inflationary pressures have eased but remain elevated, warranting a data‑dependent approach in determining the extent of future rate increases.
• The European Central Bank (ECB) reaffirmed its rate tightening commitment until inflation moves towards its 2% target. After the surprise move of easing yield curve control, the Bank of Japan (BoJ) defied speculation for another policy adjustment amidst decades-high inflation levels. The Bank of England (BoE) may hike rates less than expected due to a potential UK house price driven recession.
• Moderating pressures from higher rates and a stronger US dollar continue to benefit emerging market (EM) economies, taking pressure off their central banks. While uncertainty remains, China sentiment has improved. An end to stringent zero‑COVID policies provides a boost to the global economy.
• Key risks to global markets include central bank missteps, resilient inflation, steeper growth decline resulting in a hard landing and geopolitical tensions.

2. Portfolio Positioning

As of 31 January 2023

• We remain underweight stocks.  Earnings estimates remain too optimistic, not yet reflecting the potential for weaker demand and higher input prices weighing on profit margins.
• We remain modestly overweight cash relative to bonds, reducing portfolio duration while earning attractive yields and providing liquidity should market opportunities arise.
• Within equities, we are nearly balanced between value and growth. The slowing growth backdrop is unfavourable for cyclicals, while higher rates weigh on growth-oriented equities.
• Within fixed income we are overweight emerging market debt, where valuations offer reasonable compensation for risks. While fundamentals remain generally supportive, we maintain a cautious positioning on investment grade corporate bonds because default rates are expected to rise from historically low levels towards longer-run averages. We also hold a modest overweight to long-term US Treasuries as a risk-off ballast to equities and other risk assets.

3. Market Themes

Two in a Row?

After outpacing the rest of the world by more than 170% over the past nine years between 2013 and 2021, US equity markets notably lagged the rest of the world last year. Despite deeply negative returns across global markets in 2022, markets outside the US broadly outperformed in both local currency and US dollars, even with a persistently strong US dollar. Perhaps this was not unsurprising as some positive tailwinds appeared on the horizon late in the year, including growing evidence of slowing inflation pressures leading some central banks to hint at moderating their pace of interest rate hikes. In Asia, China surprised the world in early December with reopening from COVID lockdowns, while at the same time Europe seemed to avert an energy crisis by benefitting from warmer weather and aggressive steps to control energy usage. Lower yields in the US on the back of falling inflation are also contributing to a lower dollar, providing further support for markets outside the US, particularly emerging markets. While much uncertainty remains around the trajectory of global growth for 2023, markets outside the US could be up for a second year of outperformance as they are supported by still attractive relative valuations, higher dividend yields and more cyclical exposures that could benefit from China’s reopening and a less dire outlook for Europe.

I’m Back!

In a rare year with both equity and bond markets down by double digits, much noise was made about the death of the US traditional 60/40 balanced portfolio and the need to include allocations to less correlated sources of return. Last year’s high inflation and rising interest rates led to increased correlations between stocks and bonds as both fell in unison, leaving bonds unable to fulfill their typical role of providing ballast, particularly during risk-off periods. Despite correlations between stocks and bonds remaining elevated, noise around the death of the 60/40 portfolio has been silenced as strong returns in both stocks and bonds have led to a more than 5% return for the 60/40 in just the first month of the year. The rally in both asset classes has been supported by evidence of falling inflation and lower rates. Our analysis has shown that, in historical periods like today when inflation is declining from elevated levels, correlation between stocks and bonds can remain elevated. While perhaps still not providing diversification, if the disinflationary trend continues, the two asset classes could perform well, bringing back the 60/40 portfolio from one of its worst years ever.

 

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