This sounds reflationary for markets; as in the case of Japan, the Fed hawks are flying like doves.
This positive mix of decent growth, stable inflation (albeit at a higher level than central bank’s target), loosening financial conditions, and upward trending markets with broader participation to the upside leads us to keep our global equity allocation unchanged (with the market effect, our tactical asset allocation to equities is now slightly higher than our strategic asset allocation).
So why not increase our equity allocation further?
Despite this rosy picture, we are also aware that many things could go wrong.
The sectors of the economy that are the most affected by higher rates (for example, US commercial real estate, SMEs, etc) continue to struggle.
Sticky inflation in services and the rise of commodity prices could lead to higher headline inflation in the months to come – hence preventing rate cuts by central banks at a time when global debt keeps ballooning.
A cracking of market heavyweights could lead global indices lower.
Geopolitical conflict escalation in Ukraine or the Middle East remains a risk. Investor sentiment appears complacent and elevated equity market multiples do not leave any room for disappointment.
As such, we are keeping our global equity allocation close to our strategic asset allocation and we will not be adding more exposure to equities at this stage.
However, we believe that some sector and style rotation could continue to unfold. Indeed, the reflation thesis might trigger new leadership within equities.
We are starting to see some large-cap tech stocks stalling while sectors such as energy and materials have been outperforming the S&P 500 index recently.
Within non-US markets, we are keeping our preference for Japan and staying neutral on Europe.
Although momentum in China's equity markets is on the rise, we are currently choosing not to increase our investments in this region.
On the rates side, Treasury supply continues to rise and coupled with sticky inflation, is exerting upward pressures on long-dated bond yields.
In this context, we are decreasing our allocation to government bonds one-10 years from positive to neutral and the 10-years-plus government bonds from neutral to negative.
Proceeds are reinvested into cash, which continues to offer positive real yields.
The downtrend in credit spreads has continued towards multi-year lows. We remain neutral on credit with a preference for quality (investment-grade). On an aggregate basis, our fixed income positioning has moved from neutral to negative.
