Global Asset Allocation: The View From the UK

1. Market Perspective

• Despite expectations for slowing global growth in the back half of the year, some regions are proving more resilient in the face of tighter financial conditions, bolstered by strong household and corporate balance sheets.
• The US economy has been more robust than expected, while Europe has navigated a mild recession in Germany and continues to combat inflationary pressures. Chinese growth has disappointed, while Japan continues to benefit from an uptick in domestic demand.
• While global central banks are likely near peak tightening, they remain vigilant on inflation as it is proving stickier in some regions, such as Europe and the UK, and are at the ready to take further steps towards tightening depending on trends in the data.
• Key risks to global markets include a deeper‑than‑expected decline in growth, central bank missteps, reacceleration in inflation, tight credit conditions and geopolitical tensions.

2. Portfolio Positioning

As of 31 July 2023

• We modestly trimmed our underweight to equities; however, we maintain a cautious stance as valuations remain elevated despite expectations for the global economy to slow in the back half of the year. Within fixed income, we increased cash holdings as bonds remain vulnerable to further central bank tightening, while cash offers liquidity in an uncertain environment and still‑attractive yields.
• Within equities, we remain overweight in areas of the market with more attractive valuation support, such as small‑caps and emerging markets, which could benefit from broader equity participation in the recent rally.
• Within fixed income, we now hold reduced overweight positions in return‑seeking sectors such as high yield and emerging market sovereign and local currency bonds. We also favour inflation linked over fixed interest government bonds.

3. Market Themes

Insensitive

Despite the Federal Reserve’s (‘Fed’) funds rate reaching its highest level in over 20 years, the US economy has proven more insensitive to higher interest rates than many would have expected so far. Typically, as rates move higher the economy slows, leading to weakness in the labour market, which then flows through to the consumer. However, labour market tightness has supported real income gains amid moderating inflation, and excess savings have kept consumer balance sheets strong, ultimately buoying the broader economy. Additionally, with fixed rate mortgages making up most of the US home loan market, higher rates have not had the same impact that they have had in other regions dominated by floating rate mortgages. Corporations have also proven less sensitive to higher rates given that they previously refunded debt at low rates and that capital expenditure funding was supplemented by fiscal stimulus programmes rather than from loans at high interest rates. While so far it appears the economy may be less sensitive to higher rates than in previous cycles, it is also possible that policy has not been restrictive for long enough to have its desired effects on the economy.

Taking Shelter

Shelter inflation, which includes rent of primary residences and owners’ equivalent rent of residences (OER), is coming off its recent highs. OER closely tracks home prices, which have shown declines year over year. Given the two components make up nearly one‑third of US consumer price index (CPI) and have a lagged impact on CPI, hopes are for softening data to start to pull down overall inflation in the coming months. While this would be a welcomed sign for the Fed, recent data showing resilience in the US economy are starting to raise concerns of inflation stagnating or possibly inflecting higher. With a backdrop of a still‑tight labour market, a strong services sector, consumers still holding excess savings and a recent spike in energy and food prices, there are plenty of reasons for the Fed to remain cautious. Investors and the Fed, alike, will be eyeing details as the decline in shelter inflation may be masking a move higher in other underlying components if the economy continues to surprise to the upside.

 

For a region-by-region overview, see the full report (PDF).