Grabbing the wheel: putting money to work
Investment themes
Managing macro risk
What matters in the new regime: Sticky inflation and structurally higher interest rates. Markets are still adjusting to this environment – and that’s why context is key in managing macro risk.
Steering portfolio outcomes
We think investors need to grab the investment wheel and take a more dynamic approach to their portfolios with both indexing and alpha-seeking strategies while staying selective.
Harnessing mega forces
Mega forces are another way to steer portfolios – and think about portfolio building blocks that transcend traditional asset classes, in our view.
Read details of our Q2 2024 outlook:
Upbeat risk sentiment, for now
As Q2 kicks off, we see a more supportive near-term backdrop for risk-taking and think upbeat market sentiment can persist as inflation keeps falling.
Inflation across developed market economies has been falling from pandemic highs and looks set to reach near 2% this year. That will help pave the way for many central banks to start cutting policy rates. The Federal Reserve’s updated forecasts released in March 2024 still signal three quarter-point rate cuts this year, even as it revised up its inflation and growth forecasts.
After the recent Fed signals, we believe the bar is high for market pricing of immaculate disinflation - inflation falling to 2% targets while growth holds up – to be challenged.
Deliberately navigating macro risk
Our core view has been that in a world shaped by supply, economic activity would be on a lower growth trend. Even with the U.S. economy’s resilience through 2023, activity remains below its pre-Covid trend growth rate.
We’ve also said before that this new macro and market regime is marked by persistent, structural inflation pressures. We think U.S. inflation can fall further toward 2% this year due to falling goods prices. Yet we see inflation on a rollercoaster back up in 2025 as the drag from goods deflation fades and elevated wage growth in a tight labor market keeps services inflation higher than pre-pandemic. Mega forces, or big structural shifts we see driving returns, are also likely to push up on inflation. That’s why we see central bank policy rates staying higher than they were before the pandemic and inflation likely settling closer to 3%.
We believe that calls for staying nimble in portfolios and deliberately managing macro risks.
Taking the investment wheel
Expectations for S&P 500 earnings growth for 2024 have been revised up, with the tech sector expected to account for half of this year’s S&P 500 earnings.
We went tactically overweight U.S. stocks in January 2024, still leaning into the artificial intelligence (AI) theme. We think upbeat risk appetite can broaden out beyond tech as more sectors adopt AI and as market confidence is buoyed by recent Fed messaging and falling inflation.
We up our overweight to Japan. Solid corporate earnings and a recovery in wages and inflation after decades of sluggish progress has brightened the backdrop for Japan stocks. We think the Bank of Japan’s monetary policy stance is supportive of Japan’s markets.
Strategically, we stay selective in fixed income. In February 2024 we trimmed our maximum overweight to inflation-linked bonds, yet our expectation for inflation to settle at a level higher than markets expect keeps us overweight. We still like income within private markets. Within developed market (DM) government bonds, we keep a preference for short-term maturities.
We believe investors would benefit from a more active approach to their portfolios. This is not a time to switch on the investing autopilot; it’s a time to take the controls. It’s important to be deliberate in taking portfolio risk, in our view.
Our investment views
Our new investment playbook – both strategic and tactical – calls for greater granularity to capture opportunities arising from greater dispersion and volatility we anticipate in coming years.
Big calls
Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, June 2024
Reasons | ||
---|---|---|
Tactical | ||
U.S. equities | Our macro view has us neutral at the benchmark level. But the AI theme and its potential to generate alpha – or above-benchmark returns – push us to be overweight overall. | |
Income in fixed income | The income cushion bonds provide has increased across the board in a higher rate environment. We like short-term bonds and are now neutral long-term U.S. Treasuries as we see two-way risks ahead. | |
Geographic granularity | We favor getting granular by geography and like Japan stocks in DM. Within EM, we like India and Mexico as beneficiaries of mega forces even as relative valuations appear rich. | |
Strategic | ||
Private credit | We think private credit is going to earn lending share as banks retreat – and at attractive returns relative to public credit risk. | |
Fixed income granularity | We prefer inflation-linked bonds as we see inflation closer to 3% on a strategic horizon. We also like short-term government bonds, and the UK stands out for long-term bonds. | |
Equity granularity | We favor emerging over developed markets yet get selective in both. EMs at the cross current of mega forces – like Mexico, India and Saudi Arabia – offer opportunities. In DM, we like Japan as the return of inflation and corporate reforms brighten our outlook. |
Note: Views are from a U.S. dollar perspective, June 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
Tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, June 2024
Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.
Asset | Tactical view | Commentary | ||||
---|---|---|---|---|---|---|
Equities | ||||||
United States | Benchmark | We are neutral in our largest portfolio allocation. Falling inflation and coming Fed rate cuts can underpin the rally’s momentum. We are ready to pivot once the market narrative shifts. | ||||
Overall | We are overweight overall when incorporating our U.S.-centric positive view on artificial intelligence (AI). We think AI beneficiaries can still gain while earnings growth looks robust. | |||||
Europe | We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | |||||
U.K. | We are neutral. We find attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to fight sticky inflation. | |||||
Japan | We are overweight. Mild inflation and shareholder-friendly reforms are positives. We see the BOJ policy shift as a normalization, not a shift to tightening. | |||||
Emerging markets | We are neutral. We see growth on a weaker trajectory and see only limited policy stimulus from China. We prefer EM debt over equity. | |||||
China | We are neutral. Modest policy stimulus may help stabilize activity, and valuations have come down. Structural challenges such as an aging population and geopolitical risks persist. | |||||
Fixed income | ||||||
Short U.S. Treasuries | We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | |||||
Long U.S. Treasuries | We are neutral. The yield surge driven by expected policy rates has likely peaked. We now see about equal odds that long-term yields swing in either direction. | |||||
U.S. inflation-linked bonds | We are neutral. We see higher medium-term inflation, but cooling inflation and growth may matter more near term. | |||||
Euro area inflation-linked bonds | We are neutral. Market expectations for persistent inflation in the euro area have come down. | |||||
Euro area government bonds | We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk. | |||||
UK Gilts | We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | |||||
Japan government bonds | We are underweight. We find more attractive returns in equities. We see some of the least attractive returns in Japanese government bonds, so we use them as a funding source. | |||||
China government bonds | We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper. | |||||
U.S. agency MBS | We are neutral. We see agency MBS as a high-quality exposure in a diversified bond allocation and prefer it to IG. | |||||
Global investment grade credit | We are underweight. Tight spreads don’t compensate for the expected hit to corporate balance sheets from rate hikes, in our view. We prefer Europe over the U.S. | |||||
Global high yield | We are neutral. Spreads are tight, but we like its high total yield and potential near-term rallies. We prefer Europe. | |||||
Asia credit | We are neutral. We don’t find valuations compelling enough to turn more positive. | |||||
Emerging market - hard currency | We are overweight. We prefer EM hard currency debt due to its relative value and quality. It is also cushioned from weakening local currencies as EM central banks cut policy rates. | |||||
Emerging market - local currency | We are neutral. Yields have fallen closer to U.S. Treasury yields. Central bank rate cuts could hurt EM currencies, dragging on potential returns. |
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective, June 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Euro-denominated tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, June 2024
Asset | Tactical view | Commentary | ||
---|---|---|---|---|
Equities | ||||
Europe ex UK | We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | |||
Germany | We are neutral. Valuations remain moderately supportive relative to peers. The earnings outlook looks set to brighten as global manufacturing activity bottoms out and financing conditions start to ease. Longer term, we think the low-carbon transition may bring opportunities. | |||
France | We are underweight. Relatively richer valuations offset the positive impact from past productivity enhancing reforms and favorable energy mix. | |||
Italy | We are underweight. Valuations and earnings dynamics are supportive. Yet recent growth outperformance seems largely due to significant fiscal stimulus in 2022-2023 that cannot be sustained over the next few years, we think. | |||
Spain | We are neutral. Valuations and earnings momentum are supportive relative to peers. The utilities sector looks set to benefit from an improving economic backdrop and advances in AI. Political uncertainty remains a potential risk. | |||
Netherlands | We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations than European peers. | |||
Switzerland | We are underweight in line with our broad European market positioning. Valuations remain high versus peers. The index’s defensive tilt will likely be less supported as long as global risk appetite holds up, we think. | |||
UK | We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation. | |||
Fixed income | ||||
Euro area government bonds | We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | |||
German bunds | We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | |||
French OATs | We are neutral. Valuations look less compelling following pronounced narrowing of French spreads to German bonds. Elevated French public debt and a slower pace of structural reforms remain challenges. | |||
Italian BTPs | We are neutral. The spread over German bunds looks tight given Italy’s recently higher-than-expected deficit-to-GDP-ratio and a trajectory for the debt ratio in the next few years which is stable at best. Other domestic factors remain supportive, with growth holding up well relative to the rest of the euro area. Italian households are also showing a significant willingness to increase their direct holding of BTPs amid high nominal rates and yields. | |||
UK gilts | We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | |||
Swiss government bonds | We are neutral. The Swiss National Bank has started to cut policy rates given reduced inflationary pressure and the appreciation of the Swiss franc. | |||
European inflation-linked bonds | We are neutral. Market expectations for persistent inflation in the euro area have come down. | |||
European investment grade credit | We are neutral. We maintain our preference for European investment grade over the U.S. given more attractive valuations amid decent income. | |||
European high yield | We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the U.S. Spreads compensate for risks of a potential pick-up in defaults, in our view. |
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, June 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.