Our Asset Allocation
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EQUITIES

Back to Neutral on the United States but still Overweight Europe

Global stock markets had a volatile summer. A slump in early August on a slide by growth stocks in general and techs in particular was followed by a bounceback led by value stocks and small caps. In this volatile atmosphere, we opted to a more neutral view on US stocks, which had made the biggest gains, but remain Overweight to European markets, which offer better value.

US. After more than a year of outperformance, US equity markets slipped back in the summer, falling -2.9% since mid-July compared to -2% for global markets. Tech and growth stocks went into the summer as the biggest gainers year-on-year, but they not only fell hardest during the slump but recovered least during the rebound. Partly this reflected the mixed data coming out of the US economy – although in our view the figures continue to point to a soft landing. Given the high multiples on which the market is trading and its vulnerability to economic news, we decided to move to a more neutral view on US equities. That said, US companies are still growing earnings and the economy is proving pretty resilient. Fed rate cuts coupled with a soft landing for the economy could also help buoy markets. We have therefore moved from Overweight to Neutral on the United States, with no preference on style.

Euro zone. European equities also had a hard summer and have not yet recovered to their mid-July levels. But they still held up better than the global market average. Despite the weak economy and political uncertainty, we remain Overweight euro zone markets, which remain attractively valued in absolute terms. Also, impending rate cuts by the ECB and falling inflation should help sustain consumer spending, which has been feeble since the Ukraine war broke out. Another potential plus point for the European market is its large exposure to value stocks, which seem to be enjoying healthy momentum since the summer.

UK. The UK market has rallied strongly by +2.2% since mid-July, helped by a heavy bias toward defensive stocks which had a good summer. But it still lags global markets year-to-date and year-on-year. Looking ahead, though, the market has several benefits: pricing looks cheap, the Bank of England began cutting rates in August and there are even some modest signs the economy may be picking up. We therefore stand by our Overweight to this market.

Japan. The Japanese stock market went into the summer as one of the top-performers year-on-year and came out as the season's biggest loser, down -9.6%, not helped by narrowing rate spreads to the United States and a yen rally. The market has some bull factors: reforms to corporate governance, high corporate earnings and the end of deflation accompanied by a gradual exit from the zero-rate policy. And some bear factors, including a volatile yen and heavy bias toward technology and communications stocks. We remain Neutral.

Emerging markets. Emerging markets looked to be attractively priced but failed to benefit from this summer’s sector rotation and underperformed global markets, falling by 3.2% since mid-July. This was due in part to the fall in the Chinese market, hurt by persistently weak economic indicators, and in part to the sharp drop in Latin American indices, particularly Mexico's. The heavy weighting toward tech stocks, geopolitical risks and the weakness of the Chinese economy persuades us to tread cautiously on these markets. We nonetheless remain at Neutral on grounds of attractive value.

Unless specified, all figures and statistics in this report are from Bloomberg and Macrobond on 06/09/2024, publication completion date. 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

Maintained exposure to bond markets

We remain Neutral on fixed income. Inflation is falling across the world, central banks are cutting rates and stock markets are looking nervous, but sovereign bonds continue to offer good carry and have reasserted their role as a hedge in volatile times. We also remain Neutral on corporate bonds, which stand to benefit from the rate cutting cycle and are backed by robust balance sheets at issuer companies.

US. US sovereign yields came down sharply during the summer, back to where they began the year. The yield on 2-year Treasury bills – taken as a market proxy for the Fed Funds rate one year out – fell from 4.5% in mid-July to 3.8% at the start of September. Meanwhile, the 10-year T-bond fell from 4.2% to 3.8% undoing the inversion of the yield curve. Driving these movements are the ongoing decline in inflation and a slowdown in the jobs market, a combination that has led the Fed to focus more attention on its full employment mandate. July inflation came in below the Fed's forecasts at 2.5% year-over-year whereas the August jobless rate reached 4.2% in August, above the Fed’s expectations. Against this backdrop, Jerome Powell all but confirmed at the Jackson Hole conference that the Fed would start its rate-cutting cycle in September and that labour market stability would again be a priority. We now expect the Fed to cut rates by between 75 and 100bp in 2024. We remain Neutral on Treasuries as falling inflation and stock market volatility make sovereign debt attractive.

Euro Area. Sovereign yields in the euro area economies followed the downward path blazed by US yields over the summer, though falls were more modest.

Between mid-July and early September, 10-year Bund yields dropped from 2.5% to 2.2% and 10-year OAT yields from 3.1% to 2.9%. Risk premiums however widened, to 70 bp for France and 142 bp for Italy. The relatively modest yield declines and uptick in risk spreads reflected local factors at play: respectively, Europe’s stickier inflation – August core inflation was 2.8% – and rising political instability, notably in France. So, for the second time this year, the ECB looks set to cut its policy rate by 25 bp at its September meeting taking the deposit rate to 3.5%. It is also striking a cautious tone in light of the slow pace at which inflation is coming down. Attentive to this more cautious tone, markets are now discounting one further quarter-point cut in December. However, slowing wage inflation and weak domestic demand in many of the region’s economies, including both Germany and France, could persuade the ECB to cut rates faster than the markets expect. We therefore remain Neutral on the euro area sovereign bonds, as they are still paying attractive yields and rates might come down faster than expected.

UK. We remain Neutral on UK sovereign debt. 10-Year Gilt yields fell by 30 bp between mid-July and early September, to 3.9%. The snail-like decline in UK inflation has slowed further, likely keeping the Bank of England’s tone cautious and Gilt yields appealing.

CREDIT

We remain Neutral on both investment grade (IG) and high yield (HY) corporate debt. The asset class rode out the August surge in stock market volatility with only a minimal widening of risk premiums. What is more, performance remains impressive, particularly among HY bonds which have achieved a total return of over 5% this year. With rates coming down and company balance sheets still solid, we maintain our exposure to the corporate bond markets.

Currencies

Still Neutral on the dollar

Defying the year's trend, the dollar fell sharply against its main developed-market peers as investors revised their expectations for Fed rate cuts. Even so, we opted to stay Neutral on the EUR/USD, GBP/USD and JPY/USD crosses for two reasons: first, much of the downward adjustment now seems behind us. Second, the United States still has the strongest economy of the developed world.

Dollar Index. The US currency lost ground in its key crosses with developed and emerging market currencies, falling most sharply against the Japanese yen as their monetary policies diverge. Among emerging markets, the dollar strengthened against Latin American currencies amid political controversy in Mexico and Brazil.

EUR/USD. The European single currency rallied strongly against the dollar this summer, gaining 3% from USD 1.08 in August to USD 1.11. The rise basically reflects changing views on the Fed's rate-cutting cycle. Good news on inflation and a slowing labour market prompted the Fed to suggest it would start cutting policy rates in September and adopt an accommodative tone. The ECB meanwhile should continue its own rate-cutting cycle but struck a more cautious tone. In these circumstances, we remain at Neutral on EUR/USD. The market has now priced in its changed outlook for rates and the cross should hold steady at current levels. Also, the more vigorous US economy should limit the dollar's downside.

GBP/USD. We remain Neutral on GBP/USD. Like the euro, the UK currency gained over 3% against the dollar this summer, ending at USD 1.31 to the pound. The rally also showed the impact of the Fed shifting its tone while the Bank of England remains cautious on the painfully slow fall in UK inflation. We, however, think sterling should also hold near current levels. The rate adjustment is at least partly behind us and the US economy remains stronger, limiting downside on the dollar.

USD/JPY. The yen continued its major revival against the dollar over the summer, almost wiping out the year's declines to date. The rise reflects both the change in the Fed's monetary policy stance and the ongoing normalisation of Japan's own monetary policy. Bank of Japan (BoJ) policy rates currently stand at 0.25% and its governor has confirmed rates will gradually return to more normal levels, making it the only major central bank to be tightening financial conditions. Further, the unwinding of carry trade positions has boosted the yen's rise against the main developed economy currencies. However, we remain Neutral on USD/JPY as we think the BoJ's normalisation will be a gradual process given that underlying inflation is still well below its 2% target.

EUR/CHF. The euro lost around 3% against the Swiss franc over the summer, to 0.94 CHF/EUR. We remain Underweight this cross. Political uncertainties in Europe should be good for the Swiss franc, particularly given the wider political risks in the world. Also, Switzerland's heavy balance of payments surplus coupled with a reduction in the Swiss National Bank's foreign exchange reserves should help the franc.

ALTERNATIVES & Thematics

We retain our Underweight to gold and hedge funds

High interest rates tarnish the appeal of hedge funds and gold. Theme-wise, we still like Artificial Intelligence, Clean Energy, Reshoring, European Excellence and Health Innovation.

Commodities and gold

Commodities. Oil prices were up and down like a yo-yo this summer, trading between USD 83/bbl and USD 75/bbl in August before dipping to USD 72/bbl in early September, the lowest in more than a year. Prices were undermined by doubts about global growth and particularly by ongoing sluggish demand from China. On the supply side, OPEC members have delayed implementation of the latest quota cuts, further weakening prices.

Gold. Gold continued to benefit from its safe haven status amid heightened uncertainties and reached new record highs. The prospect of rate cuts by the world's leading central banks also adds to its relative appeal. However, we continue to prefer yielding assets to gold and/or risky assets given the still positive economic environment.

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HEDGE FUNDS

Long/Short Equity. Long/short equity funds, which specialise in non-directional strategies, could do well in the current climate of high volatility and dispersion and the current stage of the economic cycle.

Event Driven. High interest rates and a shortage of liquidity continue to discourage firms from embarking on mergers and acquisitions. Funds specialising in such deals look unattractive for now.

Fixed Income Arbitrage. Some sovereign bond funds could benefit from higher interest rates. We retain our relative interest in funds positioned in the credits segment.

Global Macro/CTA. Commodity trading advisors (CTAs) are generally useful as a way to hedge market volatility. But their recent performance has left them looking insufficiently attractive in our view.

Themes

Artificial Intelligence and European Excellence: shaken but not stirred. The investment themes of Artificial Intelligence and European Excellence both had a turbulent summer. We are standing by AI, even though we think growth stocks have lost some of their shine, because of the theme's balance of maturity and potential as well as the strong earnings growth reported by companies in the sector. On European Excellence, to cash in on a combination of bullish factors – falling inflation, cuts to ECB rates and attractive value – we are playing the theme via international companies that are leaders in their respective markets.

Clean Energy, Reshoring and Health Innovation. The Clean Energy theme is a way to invest in companies that stand to gain from the energy transition. The Reshoring theme should benefit from the return of industrial policies and perform strongly on equity markets. An ageing population, changing lifestyles more focused on physical fitness, well-being and nutrition, coupled with major technological advances (gene therapies, immunotherapy, personalised medicine, remote health services, etc.) should benefit the health sector as a whole and its innovation component in particular. This theme thus represents an opportunity to invest in cheaper valued stocks that offer long-term growth.