Our Asset Allocation in Detail

DISCOVER OUR ASSET ALLOCATION IN DETAIL

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EQUITIES

Keeping our preference for US equities

In light of geopolitical tensions and with corporate margins holding up strongly, we remain Neutral on global equities. We remain Overweight the United States market on its robust economic performance. In contrast, we remain Underweight Emerging Markets – largely because of China's economic woes – and Neutral on Europe.

US. US equities shed 2% of their value last month as rising bond yields and geopolitical uncertainty weighed on prices. US equities are still expensively valued both in absolute terms (price/equity ratios) and compared to risk-free bonds (equity risk premium). The market’s P/E is still running above its long-term average and the spread between equity earning yields and bond yields is at its narrowest since 2002.

That said, the robust performance of the US economy means corporates continue to post healthy profits. Earnings growth estimates remain far better than any other economic region. Consequently, in these circumstances, we continue to Overweight US equity markets.

Style Preference

UK. Despite retracting over the past month, UK equities still outperformed their peers due to the robust performance from the energy sector. In the current geopolitical and economic environment, we continue to favour the sector composition of the UK stock market, specifically with regards to attractively priced energy and healthcare multinationals but remain Neutral overall.

Eurozone. European markets underperformed their peers over the last 30 days, losing 5% since mid-September. The underperformance was broad-based on a sector basis, although the notable exception was the energy sector. European companies’ exposure to China was a factor, particularly for luxury goods firms. Moreover, the rise in 10-year bond yields and geopolitical risks have come at a time when the European economy was already looking more fragile than in the United States. However, European stocks still offer better value than US markets on both P/E and risk premium basis. Specifically, the equity risk premium over bonds has not been squeezed in the same way as in the United States. We remain Neutral on Eurozone equities.

Equity markets: growth in earnings per share estimates for the next 12 months

Source: SGPB, Macrobon, Macrobond 22/09/2023

Japan. Having heavily outperformed all year, the Japanese equity market contracted last month, losing 3.5%. Short-term momentum looks challenging. Nonetheless, the market is attractively valued and if the Bank of Japan ends its yield curve control policy, it would send a strong reflationary signal on the Japanese economy.

Emerging markets. We remain Underweight emerging markets. Although recent Chinese data have been more reassuring, the domestic property market still looks shaky, and we therefore remain cautious. In addition, the rise in US interest rates and US Dollar pose additional risks to emerging market equities.

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

Downgrading US Treasuries

We remain Neutral on fixed income markets, maintaining our long duration exposure, as central bank tightening cycles have likely ended, and inflationary pressures continue to ease. Persistent pressure on yields has led us to reduce our US sovereign debt Overweight exposure to neutral.

RATES

US. Bond yields in the United States continue drive upward. 10-year Treasury yields have risen nearly 60 bps in the last four weeks to 5% but found a resistance here, at least temporarily. This sharp adjustment at the long end over the past three months – while short rates have remained unchanged – has significantly reduced the yield curve inversion from -100 bp to -20 bp. The rise in long bond yields primarily reflects the health of America's economic activity and labour market. Retail sales and industrial production figures show the economy accelerated in Q3-23 with unemployment holding low at 3.8%. Another key issue is the US budget deficit. Not only is it still large but the Treasury recently revised its issuance plans markedly upwards. Given this economic backdrop, the Federal Reserve is expected to keep rates in the current 5.25-5.5% range for the next few months, supporting the rise in long bond yields. As a result, we are shifting from Overweight to Neutral on Treasuries. The resilience of the US economy and risks on oil prices increase the risk of further rate increases. However, 5% represents attractive carry, hence our Neutral stance.

UK. British bond yields did not escape the general uptrend. The 10-year gilt yield rose 20 bp to 4.6%. This largely reflected trans-Atlantic contagion from American yields in a climate of modest growth. The Bank of England is expected to keep its key interest rates high as inflation is only grudgingly edging down toward its 2% target, with the latest reading coming in at 6.1% in September). British bonds are paying attractive carry but come with greater duration risk than other sovereign debt markets and therefore, we are staying Neutral on UK debt.

Eurozone. Eurozone sovereign yields also made substantial gains over recent weeks. The 10-year bund yield increased by 30 bp to 2.9% in the last two weeks while the 10-year OAT reached 3.5%. Peripheral economies also saw yields rise – to 5% in Italy pushing the risk premium over Germany to 200 bp. This upward movement reflects (a) contagion from US yields with European growth lagging, (b) still high budget deficits, particularly in France and Italy, and (c) tight monetary policy, with the European Central Bank likely to follow the Fed’s example and keep its deposit rate at 4% for the next few months while continuing to run down its balance sheet. We therefore remain Neutral on these markets, whose attractive carry comes with an ever-present upside risk to yields.

CREDIT

Developed markets. We remain Underweight corporate credit, specifically with a view to the riskier high-yield space, in an environment of higher rates and increasing default rates.

United States: Slope of the yield curve

Currencies

An environment supportive for the US Dollar

Mirroring our shift to Neutral on United States debt, we shift from Neutral to Underweight on EUR/USD and GBP/USD pairs. We are expecting further gains for the Dollar in its main crosses, principally the Euro and Sterling. For the Yen, we uphold our Neutral positioning.

Dollar Index. The US Dollar began rallying against all currencies in summer on the back of America's better growth outlook. It has now gained nearly 5% since mid-July compared to emerging market currencies and more than 6% against developed currencies. The Mexican Peso, Indonesian Rupee and Thai Baht have lost -8.2%, -5.6% and -5.1% respectively when compared to the Dollar. In contrast, China's Renminbi held up relatively well (-2.4%) and Poland's Zloty soared after the pro-EU opposition won parliamentary elections (+3.6%). Whilst among developed currencies, the Yen, Sterling, and Euro have lost -7.6%, -7.4% and -6%, respectively.

GBP/USD. Pound sterling also lost ground against the Dollar over the month (-2%). Our decision to return to Neutral on US sovereign bonds and our expectation that the Bank of England’s tightening cycle is over provides the rationale for us taking a cautious line on Sterling. Consequently, we have moved from Neutral to Underweight on GBP/USD.

EUR/USD. The spread between US and German sovereign yields has widened continuously since the summer, topping 200 bps for the first time since the European Central Bank began to hike rates. This has kept the Euro weak against the greenback. Upward pressure on interest rates remains stronger in the Dollar than the Euro curve, so the Euro is likely to continue losing ground. We have, therefore, moved from Neutral to Underweight on EUR/USD.

USD against major currencies
100=01/01/2023

Source: SGPB, Macrobon, Macrobond 20/10/2023

JPY/USD. Having previously surged 14% since the start of the year, the Yen held steady against the dollar in the last month and consequently, our neutral stance on the JPY/USD was well positioned for this performance. Expectations that the Bank of Japan will normalise its policy in coming months (notably, dropping the yield curve control policy) have begun to recede. Although the Bank of Japan could still soon lift the 10-year yield ceiling, normalisation will be a gradual process, keeping the spread stable. Therefore, we remain Neutral on the JPY/USD.

Emerging market currencies. Disappointing economic growth and a turbulent property sector continue to be a challenge for China as it seeks to defend the Renminbi. Yet, given that the disparity in the interest rate between Chinese and US government debt continues to increase, investors are now pulling money out of the country’s bond market. The impact of this is quantified by the Renminbi falling 5.7% against the Dollar this year, and we are moving from Neutral to Underweight.

ALTERNATIVES

Diversification is Key

The high interest rate environment makes diversification into alternative asset classes less attractive. We maintain our Neutral stance on commodities and gold. Hedge Funds may have lost some of their shine compared fixed income products, yet they remain a core pillar of our diversification strategy.

Commodities and gold

Commodities. Energy prices have been highly volatile in recent weeks, responding to rising geopolitical risks and contradictory data on demand for gasoline. In September, Brent crude prices surged in response to OPEC+ production cuts. Thereafter, in early October, they fell and wiped out the summer gains on weaker-than-expected gasoline consumption and a sharp rise in US crude output. Hamas's attacks on Israel and the risk of a wider conflict in the Middle East have pushed Brent prices back up, albeit not back to their September peak. Overall, the price of crude has fallen by 2.5% in the last four weeks to $90/bbl. Natural gas prices in Europe have jumped by 33% in recent weeks as ongoing pressure from the war in Ukraine and tensions with Russia have been exacerbated by the sabotage of a Finnish gas pipeline. Nonetheless, gas prices are 60% lower than one year ago and gas storage levels are well above their historical average.

Gold. The price of gold has risen sharply since Hamas' attack on Israel from $1,820/oz to $1,980/oz as the metal fulfilled its traditional role as safe-haven asset. We nonetheless remain Neutral on gold given the attractive carry available on fixed income markets.

Main commodity prices

Source: SGPB, Macrobon, Macrobond 20/10/2023

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.

Tail Risk Protection Note. Tail risks are typically understood as unlikely but severe crisis events which shock markets and dramatically impact the value of risk assets negatively. The dotcom bust at the turn of the century and the Great Financial Crisis in 2008 and 2009 are examples of such events. Despite conditions not being favourable for it in 2022, we believe the Tail Risk Protection Note offers our portfolios yet another critical source of safety and complements the existing diversifiers.