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Asset allocation highlights – The recovery rolls on

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Christophe MOULIN
 

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Investors have been turning their attention to where economic growth will accelerate next as vaccine rollouts allow more economies to reopen. It will be the turn of continental Europe and then the emerging markets after the US. There, it looks likely that growth is peaking. Stagflation worries have emerged, even though in absolute terms, recent data has remained strong.

ASSET ALLOCATION MONTHLY - THE NEXT REOPENING WAVE

FIXED INCOME – The calm will not last

Higher-than-expected US inflation numbers have caused inflation expectations over the next year to spike higher, but medium-term expectations have moved hardly at all, and expectations for the level of the fed funds rate in two years’ time have been similarly stable.

We believe this calm will not last. There is scope for inflation expectations to rise if the current supply-demand imbalances persist and the US Federal Reserve continues to indicate that policy rates will be on hold.

In the eurozone, we see scope for further increases in core government bond yields – from their historically low levels – as economies reopen, inflation expectations rise and the ECB remains dovish.

EUROPEAN EQUITY – Up next

Steadier interest rates and a more mixed growth outlook in the US have left markets looking for direction. The exact shape and form of additional infrastructure spending is unclear as is the funding of this spending: will taxes rise and by how much? The uncertainty may have damped investor enthusiasm for US equities.

This leaves room for European equities to make up some of the ground lost relative to US equities. The near-term outlook could improve further. The distribution of Next Generation EU funds should finally begin and benefit domestic-oriented small-cap companies. An eventual Greens-led coalition in Germany could step up government spending on climate and social initiatives and be more relaxed about higher EU-level spending to support other eurozone countries.

Strong earnings by US companies in the first quarter bode well for European results in the second quarter as eurozone countries progressively loosen restrictions. Analyst expectations of eurozone company earnings have been rising faster than those for US companies, and that expected earnings growth still comes at an above-average discount relative to US equities.

In the medium term, though, we expect countries and regions such as Japan and emerging markets to offer better prospects.

EMERGING MARKETS – The reopening momentum cometh

The rising significance of the Chinese equity market has changed the dynamics of the main emerging market index, making it less cyclical and more growth-oriented. This helps explain why EM equities have underformed developed markets since February.

Now, ‘reopening momentum’ can be expected to shift, eventually reaching the emerging markets. Chinese equities in particular will likely benefit. Consequently, we expect emerging markets to make up the lost ground in the months and quarters ahead.

ASSET ALLOCATION

In the near term outlook, we see a strong global growth recovery anchored by progress on vaccine rollouts and economies reopening, a multi-trillion dollar US fiscal expansion, and easy monetary policy. Accordingly, we favour risk and equities via positions in US value stocks, EM equities, Chinese equities and Japanese equities.

We expect EM ex-Asia stocks to benefit from a cyclical recovery. In our view, valuations are not onerous.

Japanese equities are well placed to benefit from a broadening global recovery, a cash-rich corporate sector and valuations that still look cheap.

In the US, equity risk premiums are high relative to inflation-adjusted bond yields, so US equities are an attractive option even if valuations appear high. We believe value stocks have room to catch up with the mega-cap heavy S&P 500.

We are long EMU small caps, which are likely to outperform in an economic recovery. Valuations are more attractive relative to large caps.

We are underweight EMU government bonds since we expect yields to continue to rise, but we are long emerging market local debt. We see room for EM currency appreciation.

We are bullish on commodities over the medium term. We believe crude oil is supported by recovering global demand and constrained supply from OPEC and the US shale industry. We like base metals given the ongoing electrification and clean energy transition and the limited supply responses, especially in copper.

We have added a long position in US infrastructure via a basket of stocks that should benefit from President Biden’s infrastructure spending plans. This adds to our positions in the global environment, energy transition and artificial intelligence themes.

For more on our views and portfolio positioning, read

ASSET ALLOCATION MONTHLY – THE NEXT REOPENING WAVE


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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