Our Asset Allocation in Detail

DISCOVER OUR ASSET ALLOCATION IN DETAIL

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EQUITIES

Retaining our preference for US equities

We remain neutral on global equity markets, while continuing to favour US equities for their solid economic growth and robust profit margins and high but not excessive valuations. We remain neutral on European and UK markets and underweight Emerging Markets, which continue to struggle with lacklustre growth from China.

US. US equity markets have fallen sharply since the start of September, with the S&P 500 down 5% and the Nasdaq down 6%. This is the result of the continued upward adjustment of US bond yields against a backdrop of the further delay of the Federal Reserve's pivot. That said, we remain constructive on the US equity markets. Corporate earnings were solid in Q2-2023 and the sales outlook remains favourable for the foreseeable future. Moreover, as a large proportion of US companies have their debt at fixed rates, their debt servicing costs have not risen – this is true for large listed companies or small- and medium-sized enterprises alike. Against this backdrop, we remain overweight US markets despite their relatively richer valuations.

Style Preference

UK. We remain Neutral on the UK market which performed well in September (+3%) particularly on the back of the energy sector, which benefitted from rising oil prices. We continue to favour “value” stocks given that the mining, oil and banking sectors stand to benefit from the current macro-financial environment and prefer larger international players over smaller, domestically-focused counterparts.

Eurozone. European markets declined in September, with the Euro Stoxx 50 losing more than 3%. The Eurozone’s economic fundamentals seem less favourable than that of the United States, both in terms of corporate earnings (more vulnerable to interest rate rises in particular), and household consumption (where excess savings are mostly parked in illiquid assets). Inflation risks remain on the upside given the jump in oil prices and persistent labour market tensions. However, equities still offer attractive value, both in terms of P/E and equity risk premium. We therefore remain Neutral on European equities.

Earnings per share estimates for the next 12 months

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

Japan. The Japanese equity market remained relatively resilient in September, returning -0.7%. We are patiently waiting for the right time to raise our exposure to this market, looking for a catalyst to initiate this shift. One such trigger could be the Bank of Japan's decision to exit its yield-curve control policy. For the time being, we remain Underweight.

Emerging markets. We remain underweight on emerging markets due to the slow economic recovery in China and ongoing tensions in the real estate sector.

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

Long end of the curve

We remain Neutral on bond markets, maintaining our exposure to long maturities as central bank tightening cycles have likely ended and inflationary pressures continue to ease.

GOVERNMENT BONDS

US. Fixed income markets remain highly volatile with yields generally trending upward in the US. 2-year and 10-year yields have now surpassed their previous peaks, rising to 5.1% and 4.5% respectively in September. Real rates are also on the up, touching 2% for 10-year bonds. Driving the trend is a resilient economy and the latest jump in crude prices, both of which will encourage the Federal Reserve to keep its policy tight for some time yet. The Fed recently voted to hold rates at 5.25-5.50% but reiterated its determination to keep rates high for the next few quarters. We deem that the Fed have reached the peak of its tightening cycle, with core inflation clearly easing, and we therefore remain Overweight US Treasuries.

UK. Unlike the US and European markets, British sovereign yields have come down over recent weeks. The 10-year gilt yield fell to 4.3% from 4.5% at the start of the month on early signs inflation may be easing. True, the Bank of England surprised the markets by holding its key interest rate at 5.25%. However, it also decided to step up the pace of balance sheet rundown to £100 billion a year. Like the Fed and the ECB, it made clear its determination to keep conditions tight to bear down on inflation that may have started to fall but remains very high. Overall, we remain Neutral on Gilts.

Duration Preference

Eurozone. As in the United States, sovereign yields in the euro area have been on the rise. The 10-year bund hit 2.8%, up from 2.4% at start-September and the 10-year OAT reached 3.3% versus 3%. Yields also rose in peripheral economies, which maintained their spreads over German yields. We think this updrift in yields is mainly being driven by the rise in oil prices. The ECB opted to raise policy rates by 25 bps in September, taking the deposit facility rate to 4%, amidst an outlook of higher inflation and slowing growth. We see this as the probable peak of its monetary cycle, and it too is likely to keep policy tight for some quarters to come. We remain Neutral on Eurozone sovereign debt, with a preference for longer duration.

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.

Real Yields on 10y Sovereign Bonds

Currencies

Revisiting the Yen

We remain Neutral on the euro/dollar and sterling/dollar. The end of central bank tightening cycles and widening trans-Atlantic growth differential should be offset by the gap in the balance of payments. We moved to neutral from underweight on the Yen.

Dollar Index. The US dollar remains on an uptrend against major developed and emerging market currencies. The dollar index (DXY) gained 3.56% since the beginning of September. Among emerging currencies, the Asian crosses with the dollar continue to lose ground (-1.28% for South Korean Won, -0.80% for New Taiwan Dollar and -0.64% for the Chinese Yuan) as they all feature lower inflation and lower interest rates than the United States. Against Latin-American countries, the dollar remains broadly stable, mirroring stable rate spreads over the Fed funds. As for crosses with other developed countries, the dollar's rise reflects the widening gap in growth outlooks as monetary tightening cycles come to an end.

GBP/USD. We remain at a Neutral weighting in sterling against the dollar. The British currency has fallen sharply against the dollar since the beginning of September, losing 4.0% to GBP/USD 1.22. The decline reflects the end of monetary tightening at the Bank of England, a move that took the markets by surprise as they were expecting another rise at the September meeting. Growth trends are also diverging, with the British economy being the laggard. However, we remain Neutral on the GBP/USD on the basis of an improving balance of payments and the still restrictive tone struck by the BoE.

EUR/USD. Like the pound, the euro has continued to lose ground against the dollar since the start of September, dropping 2.5% to EUR/USD 1.06. Behind the weakening lies, first and foremost, the end of policy tightening at both Fed and ECB, locking in the short-term rate spread for the next few months. Secondly, there are notable disparities in economic growth rates, with the United States economy demonstrating resilience while the European economy shows signs of weakening. This translates into widening spreads in long yields which give further support to the dollar. That said, we remain Neutral on the EUR/USD as the Eurozone current account with the US has returned to a surplus and falling inflation should limit downside on the euro.

USD against Major Currencies

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

JPY/USD. We are going from Overweight to Neutral on the Japanese currency. Since H2 2023, the Bank of Japan has lifted the ceiling on its yield curve control system from 0.50% to 1% as underlying inflation reached 3%. Moreover, Japanese growth has surprised on the upside, with a positive contribution from domestic demand. On the other hand, weak salary growth is likely to mean that the BoJ's normalisation of policy will be a gradual process.

Emerging market currencies. Attention remains focussed on China as its Central Bank asserts its tough stance of defending the Renminbi against a stronger dollar in the face of weakening exports, a turbulent real-estate sector and, most significantly, a market sentiment defined by uncertainty. Whilst at the start of September the Renminbi fell to its lowest point against the dollar in the last 16 years, the early release of lending data provided the catalyst for the currency to bounce back from that level for now.

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. The oil price rebounded sharply in September, briefly topping USD95/barrel when OPEC+ (OPEC and Russia) members announced they would continue to cap their oil production. However, we see limited upside on crude due to the slowing economic outlook in the major developed economies and China. The rise in oil prices is also prompting a resurgence in US production back to pre-Covid levels. There is a risk that OPEC+ may prolong or even intensify its production cuts, however, this would likely prove short-lived given its adverse effects on the global economy. Finally, European gas prices remain low, reflecting still high inventories.

Gold. Gold has remained relatively stable in recent weeks amid easing inflationary pressures and positive real interest rates. We remain Neutral on gold after taking the profits from our Overweight.

Main commodity prices

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 dot-com 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.