September 2022

Global Asset Allocation Viewpoints

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Welcome to our latest Asset Allocation Viewpoints - your monthly source for actionable insights on portfolio positioning from our Asset Allocation Committee and Multi-Asset team. 

Market Perspective

As of August 31, 2022

  • While seeing increasing evidence of moderating inflationary pressures in some countries, central banks to remain steadfast in tightening policies as inflation is not likely to return to target levels in the near term.
  • The US Federal Reserve (Fed) strongly reinforced its commitment this past month to its tightening policy, prioritizing inflation fighting over economic growth. Despite facing prospects of weaker growth, the European Central Bank (ECB) is expected to ramp up rate hikes to fend off energy-driven inflation pressures, while the Bank of Japan (BoJ) remains on the sidelines.
  • Several emerging markets (EM) are being forced to tap in to reserves to defend their currencies against the rallying US dollar and elevated import costs, while China continues to try and incrementally bolster growth through supportive policies as the country contains the spread of the coronavirus.
  • Key risks to global markets include central bank missteps, persistent inflation, potential for a sharper slowdown in global growth, China’s balance between containing the coronavirus and growth and geopolitical tensions.

Portfolio Positioning

As of August 31, 2022

  • We remain moderately cautious on risk, through our underweight to equities and bonds and overweight to cash. Slowing growth and declining earnings remain a challenge for equities, while persistent inflation and higher rates could weigh on bonds. Cash is an attractive alternative with higher short rates.
  • Within equities, we are nearly balanced between value and growth. Slowing growth backdrop unfavorable for cyclicals, while higher rates weigh on growth-oriented equities.
  • Within fixed income, although we remain constructive on floating rate loans, we took an opportunity to trim our overweight position in the sector as spreads have rallied sharply over the past month.

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Market Themes

As of August 31, 2022

It Fooled You Once…

Coming out of the annual Jackson Hole meeting, Fed Chairman Jerome Powell’s speech, unsurprisingly, had a strong tone reinforcing the Fed’s intention to fight inflation at any cost, a 180-degree reversal of his ‘inflation is transient’ tone delivered the same time last year. But, just like last year when the Fed misread the growing threat of persistent inflationary forces and underacted, they may be misreading the trajectory of inflation once again. While lingering supply chain impacts from the pandemic and the Russia-Ukraine conflict over the past year further exacerbated inflationary pressures, we are now starting to see key input costs–such as oil, lumber, and copper–sharply decline. Recent jobs data has also pointed to higher participation rates, which should help ease the tight labor market and pressure on wages and while other ‘stickier’ components of inflation–such as rents and owners’ equivalent rents–are still on the rise, the pace has moderated in recent months. Although it is unlikely that inflation returns to the Fed’s 2% target anytime soon, it could be falling a lot faster than suggested by the Fed’s tightening, leaving markets to wonder if next year’s speech is about rate cuts.

Contribution to CPI by Category

As of July 31, 2022

Graph1

Past performance is not a reliable indicator of future performance.

Sources: Bloomberg Finance L.P.

House of Cards

Pandemic-fueled demand for space, ultra-low mortgage rates, and low supply proved the perfect mix that set the housing market on fire, with home prices surging over 40% since the start of the pandemic. Unfortunately, the tides have turned amid tighter Fed policy, as mortgage rates have spiked higher, with the 30-year fixed rate moving from below 3% up to 6% since early 2021. That abrupt leap in rates has quickly stifled demand, sending prices and sales lower, and is already forcing some mortgage lenders to begin layoffs amid the downturn. While there is clearly some excess in home valuations, particularly in certain regions that saw the strongest demand, it may be a stretch to draw parallels to the 2008 house of cards that came crashing down, as credit fundamentals of borrowers today are less of an issue. In fact, many buyers, and particularly first-time home buyers, have been sidelined as climbing financing costs are continuing to keep affordability out of reach and more than offsetting the recent softness in home prices. However, going forward, the real impact of a weakening housing market may be on sectors of the economy, such as construction spending and mortgage lending, as well as broader consumer spending.

Housing Affordability vs. Mortgage Rates

As of August 31, 2022

Graph2

Past performance is not a reliable indicator of future performance.

Sources: Bloomberg Finance L.P.

The 30-Year Fixed Mortgage Rate reflects the U.S. Home Mortgage 30 Year Fixed National Average Index (Source: Bankrate.com).

Regional Backdrop

As of August 31, 2022

Regional Backdrop

Click each region below for more details

Positives
 
  • Strong corporate and consumer balance sheets
  • Pent-up demand for services and capex
  • Resilient labor market
  • Supply chain issues improving rapidly

Negatives

  • Persistently high inflation
  • Restrictive monetary policy
  • Challenging environment for earnings

Positives
 
  • Fiscal spending likely to increase
  • Equity valuations attractive relative to the US
  • European Union unity is strengthening

Negatives

  • Recession risk is very high
  • Industrial production will be dampened by energy shortages
  • ECB is tightening
  • Sovereign debt risks are rising
  • Limited long-term catalysts for earnings growth

Positives
 
  • Very attractive equity valuations
  • Improving corporate governance
  • Monetary policy remains accommodative
  • Low inflation relative to the rest of the world

Negatives

  • Limited long-term catalysts for earnings growth
  • Global trade volumes are slowing
  • Uptick in inflation is leading to tighter monetary conditions

Positives

  • Chinese authorities are easing monetary, regulatory and credit conditions
  • Equity valuations are attractive relative to the US
  • COVID concerns have decreased

Negatives

  • Chinese regulatory actions are weighing on confidence
  • Chinese housing concerns have impacted industrial activity
  • Geopolitical risks are elevated
  • Global trade volumes are slowing

Asset Allocation Positioning

As of August 31, 2022

These views are informed by a subjective assessment of the relative attractiveness of asset classes and subclasses over a 6- to 18-month horizon.

Positioning Key

Asset Classes

Despite a recent bounce, stocks remain vulnerable amid tightening liquidity and a hawkish Fed. Earnings expectations are beginning to be pressured by slowing economic growth and persistent cost inflation.

Tighter global central bank policies and elevated inflation are counteracting recession fears to keep yields rangebound. Credit spreads offer reasonable compensation for risk with prospects for defaults to rise from historically low levels.

Equities

Regions

US equities remain expensive on a relative basis. However, the less cyclical nature of the US economy should provide some support as global growth weakens.

The global growth outlook may benefit from potential stabilization in China. However, inflation concerns, tighter central bank policy and energy shortages in Europe could weigh on the global economy.

Valuations are compelling, but elevated energy costs and weakening manufacturing activity have made a recession highly likely. Meanwhile, the ECB is unable to provide support with inflation concerns rising.

Despite cyclical concerns, Japan offers cheap valuations, relatively lower inflation, an improving outlook for the yen, an accommodative monetary policy stance and improving corporate governance.

Valuations and currencies are attractive. The medium-term outlook in China appears attractive due to prospects for significant policy support and less stringent COVID lockdowns; however, further outbreaks remain a risk.

Style & Market Capitalization

Relative valuations for value stocks remain attractive, and energy sector earnings could provide support. However value stocks may weaken as inflation concerns give way to increasing recession risks.

Value stocks offer attractive valuations. However, earnings could face significant pressure as cyclical risks are rising and amid a challenging geopolitical backdrop.

Small-cap stocks offer historically attractive relative valuations, reflecting elevated recession concerns. However, thus far, small-cap earnings have held up well during economic weakness and could improve dramatically if the outlook stabilizes. Higher-quality bias is warranted.

Small-caps offer idiosyncratic opportunities and could benefit from relatively stable global growth. However, caution is warranted due to US dollar strength and a potential flight to quality that could favor large-caps.

Inflation-Sensitive

Commodity prices have weakened somewhat recently due to economic concerns and waning demand; however, real assets offer an attractive hedge to a sustained period of elevated inflation.

Bonds

Moderating growth and rising recession risks are offsetting upward pressure on interest rates from continued Fed tightening and elevated inflation.

Rates biased higher as developed market central banks, outside the BoJ, remain hawkish as they continue to combat high inflation. The US dollar remains supported by the Fed’s tightening and safe-haven trade.

An upward move in longer rates appears to have stalled as rates weigh recession risks and further Fed tightening. The sector provides portfolio ballast in a risk-off scenario but remains vulnerable should elevated inflation persist.

Falling breakevens are reflecting peak inflation, although the sector could offer protection if Fed tightening fails to bring inflation down.

Credit fundamentals and the default outlook remain stable, but may be challenged as economic growth continues to deteriorate. Yields are still at compelling levels despite recent rally, but spread volatility is expected to continue.

Loans’ short duration profile is attractive for a rising rate regime, but that benefit may be waning. Solid fundamentals and demand for yield remain supportive, but liquidity remains a risk.

Attractive yield levels in select markets versus developed markets but relative valuations are closer to fair value and in line with risks. Prospects for stimulus from China are supportive.

EM yields are at attractive levels amid central bank tightening and risk-off sentiment. Potential for EM currency stabilization would be supportive.

* For pairwise decisions in style & market capitalization, positioning within boxes represent positioning in the first mentioned asset class relative to the second asset class.

The asset classes across the equity and fixed income markets shown are represented in our Multi-Asset portfolios. Certain style & market capitalization asset classes are represented as pairwise decisions as part of our tactical asset allocation framework.

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Portfolio Implementation

As of August 31, 2022

Equity

Tactical Allocation Weights

Chart1b
Chart1

Fixed Income

Tactical Allocation Weights

Chart2b
Chart2

1 U.S. small-cap includes both small- and mid-cap allocations.

Source: T. Rowe Price. Unless otherwise stated, all market data are sourced from FactSet. Copyright 2022 FactSet. All Rights Reserved.

These are subject to change without further notice. Figures may not total due to rounding.

Neutral equity portfolio weights representative of a U.S.-biased portfolio with a 70% U.S. and 30% international allocation; includes allocation to real assets equities. Core fixed income allocation representative of U.S.-biased portfolio with 55% allocation to U.S. investment grade.

Important Information

Any specific securities identified and described are for informational purposes only and do not represent recommendations.

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial, and tax advice before making any investment decision. T. Rowe Price group of companies, including T. Rowe Price Associates, Inc., and/or its affiliates, receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation, or a solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions that prohibit or restrict the distribution of the material, and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

USA: For Institutional Investor Use Only. T. Rowe Price Investment Services, Inc., and T. Rowe Price Associates, Inc.

© 2022 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.

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