Allocation Views: It’s tricky

Preview

Despite a constructive growth outlook, global equity markets remain in a fragile state. Even with an ongoing disinflationary process and likely rate cuts, rising volatility suggests this is not the time to take aggressive positions in portfolios. Although we believe global stocks still have greater performance potential than global bonds, we maintain the neutral asset allocation stance.

In this month’s Allocation Views, we see persistent divergences in monetary policy and reflect this in our preferences among high-quality bonds. Across asset classes and sectors, we see markets fully discounting the good news that is needed to justify elevated valuations presenting us with a “tricky” investment environment.

Macro themes driving our views

Growth is constructive

• Leading economic indicators suggest continued global growth.
• Recession risks have passed for some developed economies and are low especially for the United States.
• Despite stabilization, growth levels remain at or below trend.

Inflation risks are more balanced

• Significant progress has been made, although it has been bumpy, and inflation is still above targeted levels.
• Elevated services inflation is expected to moderate more slowly due to tight labor markets.
• Core goods inflation has already normalized, but freight cost rises may offset this.

Divergent policy cycles

• More central banks are likely to start cutting rates soon, but with a greater divergence of outcomes likely.
• Inflation progress allows policymakers leeway to balance growth and inflation objectives.
• Central banks remain cautious and will seek data that confirms disinflation before acting.

Portfolio positioning themes

Balance of risks across assets

• A constructive macro environment is typically associated with strong markets, which would support a tilt toward riskier assets.
• However, the level of premium discounted in risky assets remains elevated, and extended sentiment leads to fragile equity markets.
• Policy changes may offset growth and inflation surprises, and the collective mix is more balanced.

A changing equity landscape

• Diminished conviction on the growth outlook for Europe ex UK stocks sees us trim our optimism toward this region.
• The emerging markets remain our preferred region as they are geared to an improving global economy.
• We are marginally less cautious over UK equities but continue to find Canada and Pacific ex Japan less appealing on valuation grounds.
• China remains the most volatile equity market, but policy is more supportive.

Attractive yields for bonds

• Lower yields more recently diminish the return potential from global bonds, causing us to reduce our longer-duration preference in government bonds.
• Easing cycles are likely to begin this year for Western economies, and we find market expectations to be fair.
• Sustained growth supports some optimism toward riskier assets such as high-yield corporate bonds, which we now prefer over bank loans.
• We see value in elevated levels of real yields balanced by continued volatility.