Our Asset Allocation in Detail

DISCOVER OUR ASSET ALLOCATION IN DETAIL

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EQUITIES

Keeping our preference for US equities

Softer inflation and the prospect of lower rates should continue to buoy global equity markets in the coming months. However, with US growth slowing and Europe’s sluggishness set to persist, we remain cautious, retaining our Neutral position on global equities. We remain Overweight US markets as the US economy should continue to outperform. We have also moved from Underweight to Neutral on Japan.

US. US stock markets rebounded strongly (+6% over the past 5 weeks) on the back of lower inflation figures and the likely end of the rate-tightening cycle. Corporate earnings have been heading in the right direction, helping to keep down valuation multiples. We are standing by our Overweight to US equities, despite a still depressed equity risk premium (gap between expected returns on bonds and on equities). The US economy, despite some emerging signs of slowdown, should remain firm and outperform its peers. Moreover, despite their massive rally this year, even tech and growth stocks are not trading on excessive multiples while new tech and AI companies are reporting solid results and guidance. Lastly, momentum indices have moved from positive to very positive territory.

Style Preference

Europe. Although their results season wasn’t as strong, European markets held up over the past month, putting on nearly 6%. They were helped by declining bond yields and oil prices against a backdrop of slow but, importantly, not slower, GDP growth. P/E ratios for the market and many individual sectors remain attractive and the equity risk premium is close to its long-term average. However, this year's strong performance – intensifying over the last month – has at least partly been driven by risk-on elements, both in terms of countries or sectors (Italy and Spain, tech, pharma, and consumer). We therefore remain Neutral on euro area equities.

UK. The UK equity market was one of the major exceptions, falling by 1.5% over the last 5 weeks due to its heavy energy weighting. Even so, UK equities stand to gain from the same positive factors as their European peers: near-neutral valuation, falling inflation and the prospect of lower rates to look forward to. Consequently, we remain neutral on the UK market and continue to favour value stocks including mining, oil, and banking.

US equity market – Earning results positive surprises

Source: SGPB, Macrobond, Macrobond 24/11/2023

Japan. The Japanese market underperformed the global index by nearly 4% last month following strong gains in H1. On the plus side, momentum has turned positive again. Moreover, the Bank of Japan continues its slow march away from yield curve control, confirming that deflation will soon be a thing of the past. Against this background, we are moving from Underweight to Neutral.

Emerging markets. We remain Underweight emerging markets, largely due to the fragility of the Chinese economy, which makes up a large part of the emerging market indices.

Past performance does not prejudge future performance. Investments may be subject to market fluctuations, and the price and value of investments and the resulting revenues may fluctuate downward and upward. Your capital is not protected, and original investments may not be recovered.

FIXED INCOME

A favourable environment for corporate bonds

We have moved to Overweight on fixed income markets, with a preference for investment-grade (IG) corporate debt and duration. As inflation returns to normal and labour market pressures ease, investors are pricing in the end of monetary policy tightening – good news for bond markets. Weaker growth, solid corporate balance sheets and high carry all add to the appeal of IG corporate debt.

RATES

US. Sovereign bond yields have remained volatile over the last 4 weeks. 10-year Treasuries topped 5% in mid-October on fears of an overheating economy and the Federal government’s ballooning borrowing projections, only to plunge back to the 4.5% last seen in early September. The plunge owed much to inflation figures that revealed price dynamics are moving back toward their 2% target. Yields also moved lower on signs of a moderating jobs market, which led the Fed to virtually rubber stamp the end of the rate hike cycle. Finally, the US Treasury revised down its issuance programme, boosting long-duration debt. Notwithstanding this, the US government will still be borrowing heavily in 2024, and upside risks on Treasuries remain. We therefore remain Neutral on this market.

Eurozone. Bond yields mirrored the volatility seen in the US. The 10-year OAT hit 3.5% in mid-October, then slumped in November to 3.2%. The story was similar for peripheral sovereign bonds. Italian 10-year bonds fell 70 bps to 4.3%, squeezing its risk premium. Part of this move is down to correlation with the US, but local factors are also at play, including unexpectedly good inflation figures for October with core inflation apparently on track toward 2%. We nonetheless remain Neutral on European sovereign debt. Momentum may be good, but the ECB may well retain its tightening bias with services inflation still running high and some governments looking at hefty borrowing requirements.

UK. We remain Neutral on Gilts. UK yields also tracked the ups and downs of European markets. Inflation surprised on the downside, but with UK services inflation remaining high, we expect the Bank of England to retain its hawkish bias.

CREDIT

U.S. and Euro area. We continue to prefer Investment Grade corporate bonds. Companies are still sitting on solid balance sheets, with relatively low and falling debt ratios. They are also earning good returns on their substantial cash piles, which means that, for large companies, their net cost of debt has remained steady despite higher interest rates. So, against a backdrop of a slowing economy and the likely end of central bank policy tightening, we see solid balance sheets and attractive carry of 4.5% for European corporate bonds. We are Overweight.

European bond yields

Source: SGPB, Macrobond, Macrobond 24/11/2023

Currencies

Back to dollar Neutral

The dollar lost much of its September and October gains against leading world currencies on the prospect of lower rates and a soft landing for major economies. Consequently, we are moving to Neutral on the EUR/USD and GBP/USD as central bank tightening appears to be over and the next move is likely to be down.

Dollar Index. The dollar lost ground in its main crosses. The DXY index has fallen 3% in five weeks. The fall was sharper against emerging currencies, with the MXN, CZK, and CNY up 6%, 5% and 2.5% over the period. These moves mainly reflect the rising conviction that the Federal Reserve will be cutting rates in 2024 while its economy continues to grow.

EUR/USD. After a bearish summer when it touched USD 1.04, the euro has been on an uptrend since mid-October and now stands at USD 1.09. This mainly reflected improving market sentiment, with rate cuts being priced in for 2024. As a result, we moved from Underweight to Neutral on EUR/USD. The gradual slowdown of the US economy and still meagre growth in Europe should keep the euro in its current range. Also, the start of their rate cutting cycle should also help support the euro, given that the Fed and ECB are expected to move in step.

GBP/USD. Sterling has also been rising against the dollar in the last four weeks, gaining 3.8% to 1.26 GBP/USD. Comparable to the euro, the movement is being driven by better sentiment as October inflation demonstrates signs of converging towards its 2% target while the economy continues to grow modestly. We have moved from Underweight to Neutral on the GBP/USD. The BoE has also likely reached its peak rate and should track the Fed and ECB with its rate cuts, keeping sterling close to current exchange rates.

USD/JPY. We remain Neutral on the USD/JPY. The yen has been falling since October, losing 3%, as markets have revised where they think Japan's normalisation of monetary policy will leave rates. Since H2 2023, the Bank of Japan first lifted the ceiling on its yield curve control system from 0.50% to 1%, then announced that the 1% was a benchmark rather than a ceiling. This policy normalisation reflects the fact that Japan’s inflation has at long last breached 2%, with annual headline and core inflation topping 3% and 2.6%, respectively. However, we still think policy tightening will be a gradual process given the weakness of Japanese economic activity.

Emerging market currencies. Geopolitical tensions surrounding the Israel-Hamas war have eased, leading to the Israeli Shekel being the world’s best performing currency in November. This performance is underpinned by the Israeli government’s compelling balance sheet and the determination of the central bank to defend its currency as well as financial inflows from abroad boosting investor confidence.

USD against major currencies
100=01/01/2023

Source: SGPB, Macrobond, Macrobond 24/11/2023

ALTERNATIVES

A limited appeal in a context of high rates

Current high interest rates are making diversification into alternative investments less attractive. We remain Neutral on commodities but reduce our position on gold to underweight. While Hedge Funds are a reasonable option for diversification, they remain less attractive compared to fixed-income products.

Commodities and gold

Commodities. Oil prices shot up in early October only to enter a period of volatility and then fall by nearly 7% in November, from USD 88/bbl at end-October to USD 81.5/bbl. This reflected a sharp rise in production in the US and Latin America, to 13 million and 9 million barrels a day, respectively, with no counter-cut in output by OPEC+. This leaves the world with rising supply and falling demand. On natural gas, European prices have fallen nearly 20% over recent weeks after a jump in October following sabotage of the Finnish pipeline. Overall, Europe still has high stocks of gas (98% of storage capacity in November) which should help cap prices for the next few months.

Gold. Gold rose sharply on its safe-haven status and moderating yields, staging a recovery from GBP 1,820/ounce in early October to as much as GBP 2,040/ounce in late November. Given the attractive carry available on the bond market, we are taking advantage of the latest surge, moving from Neutral to Underweight on Gold.

Oil Supply (millions barrels per day)

Source: SGPB, Macrobond, Macrobond 24/11/2023

Real Assets

Infrastructure & specialist property. We hold an allocation to a diversified portfolio of infrastructure (such as energy storage and efficiency, smart grids, waste-to-energy, air treatment and digital infrastructure) and specialist property assets (including care homes and e-commerce and logistics warehouses). These real assets offer additional diversification from other risk assets such as equities, as well as an attractive income stream and reasonable sensitivity to inflation.

Hedge funds

Hedge Funds. In unstable market conditions hedge funds can help a portfolio, but selectivity is key. We prefer strategies which hold their own in bear markets, such as Merger Arbitrage, trend followers and Equity long/short. These strategies provide relatively safe, uncorrelated sources of returns from equities. Our hedge funds allocation has performed well over 2022 and have been a great diversifier in our strategies.