Our Asset Allocation in Detail

DISCOVER OUR ASSET ALLOCATION IN DETAIL

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EQUITIES

A preference for US equities

We remain Neutral on equity markets but have adjusted our geographical biases. Our preference to shift towards US equities is based upon their stronger economy and earnings outlook. We maintain our exposure to European and UK equities but have trimmed to Neutral. We remain Underweight emerging markets, particularly China.

US. In contrast to a strong performance in July, the US equity markets contracted slightly in August, with the S&P500 and Nasdaq both losing 1%. Behind this lay the sharp rise in long yields over the month, which squeezed the yield gap between equities and bonds. Despite this, we have increased exposure to the US equity market. Economic prospects remain positive, with resilient household consumption and an accommodative fiscal policy set to favour companies’ earnings going forward. Moreover, US inflation is returning to normal levels and labour market imbalances are correcting. Consequently, the Fed is likely to hold the Funds rate at 5.50%, capping the risk of any further surge in long yields. We increase our exposure from Neutral to Overweight.

Style Preference

UK. The UK equities index followed the global downturn and is currently facing the biggest risk of a hard landing among its peers. Weaker global growth, industrial commodities, and sluggish domestic consumer spending amidst declining real wages are to blame. Even though we maintain our preference for the attractive valuations of British multinationals, we are reducing our exposure to small and mid-cap companies that are more vulnerable in this environment of stagnating growth. Consequently, our overall exposure has shifted to Neutral from Overweight.

Eurozone. Similarly, European equities contracted during August, with the leading index down 2.8%. However, unlike the United States, this mainly reflected a weakening growth outlook for the area and its key trading partners. Economic data published over the summer illustrated a slackening economy, with domestic demand shrinking in the major euro economies, dampening corporate revenue outlooks. Further, China’s weak post-Covid growth has affected European equity indices, particularly “Growth” stocks. Lastly, the ECB is set to keep monetary policy restrictive for some months to come, which is unhelpful for European stock prices. Nonetheless, stocks continue to offer good value compared to sovereign yields, particularly “Value” stocks. We are moving from Overweight to Neutral.

Earnings per share estimates for the next 12 months

Source: SGPB, Macrobon, Macrobond 01/09/2023

Japan. This market is still the top-performer among developed economies since the turn of the year, up by more than 25% in local currency (9.5% in sterling terms). The Bank of Japan is likely to keep policy more accommodative than other central banks, weakening the yen. We remain Underweight on Japanese equities.

Emerging markets. We remain Underweight emerging market equities given China's disappointing economic bounceback and ongoing problems with its real estate sector. Equity markets in other emerging economies are holding up well for now, supported by the trend towards “friendshoring”.

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

Duration remains attractive

We remain neutral on bond markets. Considering the expected end of the central bank tightening cycle and the easing of inflationary pressures, we prefer exposure to long maturities specifically with regards to government debt.

rates

US. Volatility was the big theme for Treasuries over the summer. Yields on the 10-year T-bond rose sharply at first, from 3.8% at end-July to nearly 4.3% by mid-August, before falling back to 4.1%. Amidst normalising inflation, the real 10-year yield surged to 2%, a high since 2007. This strong volatility reflects the resilient US economy, driven in large part by strong consumption. Confirmation that inflation is converging towards 2% for both goods and services should give the Fed space to hold policy rates at 5.25-5.50%. But the resilient labour market will encourage it to maintain its restrictive tone for some quarters to come. All in all, the upside on yields should remain limited and we are standing by our Overweight on Treasuries as both nominal and real yields are attractive.

UK. Gilts mirrored the brief surge in Treasury yields before retreating back to 4.40% throughout August. Growth remains poor for a British economy facing tight monetary conditions and structural constraints. The Bank of England looks set to hike its policy rate further from its current 5.25% as the core inflation trend is stronger than in the Eurozone or United States, at 6.9% in July versus 5.5% for the zone and 4.7% for the US. We remain Neutral on Gilts.

Duration Preference

Eurozone. In contrast to the US, yields on euro area sovereign debt held broadly stable over the summer. The 10-year bond dropped back to 2.50%, having touched 2.70% mid-August, while the 10-year OAT ended the month at 3%. Yields paid by peripheral economies also held steady. The 10-year BTP continued to pay 4.1%, making it the top performing sovereign bond by total return this year. The desynchronization with US rates is explained by the euro area’s sluggish economic performance. Also, as inflation is gradually coming back down to more tolerable levels, we think the ECB has likely topped out the rate-hike cycle in Q2 2023. Overall, given risks to growth and less attractive real yields than in the United States, we remain Neutral on Euro-denominated sovereign bonds.

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

A return to Neutral stance on the US dollar

After playing the decline of the dollar, we move to Neutral on the euro/dollar and sterling/dollar pairs. These movements reflect the end of central bank tightening cycles and the widening gap in growth dynamics.

Dollar Index. During the month of August, the dollar appreciated against the major developed and emerging currencies. Against developed currencies, the appreciation of the dollar reflects the growth differential between the United States and its mostly Western peers. In Asia, the dollar appreciated by 3.6% against the Korean Won, 2% against the Chinese Yuan and 1% against the Indian rupee. While these movements reflect doubts about Chinese growth, they are also explained by broadly accommodative monetary policies against the dollar in a context of lower inflation in Asia. In other emerging economies, the dollar remained stable against the Mexican peso but gained ground against the Brazilian real following the start of monetary loosening in Brazil.

GBP/USD. We are moving from Overweight to Neutral on GBP/USD. In August, the pound fell 1.30% against the dollar amid a widening long-term interest rate spread. While the Bank of England should continue its tightening cycle, with a terminal rate at 5.75% against 5.25% at the end of August, we believe that the growth momentum gap will favour the US currency.

EUR/USD. Much like the pound, the euro fell by 1.2% against the dollar throughout August to reach 1.08 due to changes in the rate differential. The ECB and the Fed reached their peak monetary tightening at 3.75% and 5.50% as inflation in both economies slowly converges towards the 2% target. However, US long rates have risen more than European long rates due to different growth dynamics, favouring the US currency. Thus, as we expect stable interest rates short-term spread but a slight widening of the long-term spreads, we move from Overweight to Neutral on the EUR/USD parity.

FX change in August vs USD, %

Source: SGPB, Macrobon, Macrobond 01/09/2023

JPY/USD. The Japanese currency continues to decline against the dollar amid a widening interest rate spread. Indeed, Japan maintains, for the moment, its yield curve control regime where the Bank of Japan holds its course at 1% for the 10-year JGB. Markets are still expecting a gradual exit from this regime, given that core inflation in Japan reached 3.2% in May and core inflation 4.2%. Nevertheless, nominal wage growth remains very weak (0.9% year-on-year in April) and is expected to delay the BoJ's exit from this monetary regime.

Emerging market currencies. Spotlight remains on China as the Renminbi continues to decline towards its lowest level against the dollar since the 2008 financial crisis. This is mainly due to the overwhelming impact of weakening exports, a turbulent real-estate sector and more generally, the absence of consumer confidence. The stark reaction to this decline is quantified by the decision of China’s central bank to cut the interest rate and inject over $100bn of short-term liquidity into the country’s banking system, however, in the short term, we see little upside for the Renminbi.

ALTERNATIVES

A limited appeal in a context of high rates

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

Commodities. The price of Brent oil has recovered, rising more than 10% over the summer to nearly 90 USD/bl. This increase mainly reflects the impact of OPEC+ production cuts and the stabilization of inventories in developed economies. In Europe, the price of natural gas is normalizing to its level at the beginning of 2021, given continually high inventories and low demand. Industrial metals remain generally on a downward trend due to the weakness of the Chinese economic recovery.

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.