March 2023
Global Asset Allocation Viewpoints
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
- Global growth is proving resilient in the face of tighter monetary policies, however, impacts of central banks’ tightening are still expected to weigh on economic growth and earnings outlook in the back half of the year.
- Despite declining goods inflation, services inflation remains sticky on the back of higher wages, keeping the U.S. Federal Reserve and other central banks hawkish.
- While uncertainty remains, optimism surrounding China reopening and resilient growth in Europe, supported by declining energy costs, could help buoy the global economy.
- Key risks to global markets include central bank missteps, resilient inflation, steeper growth decline resulting in a hard landing, and geopolitical tensions.
Portfolio Positioning
- We remain underweight equities and bonds in favor of cash. Equity valuations remain extended in the face of tightening liquidity and slowing growth. Bond yields are likely to remain volatile amid mixed economic data and central bank policy shifts, while cash offers attractive yields and stability.
- Within equities, we are overweight areas with more attractive valuation support such as small/mid-caps, global ex-U.S. and emerging markets. We also maintain an overweight to core equities, with less extreme interest rate sensitivity and cyclicality.
- Within fixed income, we remain overweight high yield, floating rate loans and emerging market bonds, where yields still offer reasonable compensation for risks, despite persistent market volatility.
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Market Themes
Too Hot to Handle
Recent good news on consumer spending, sentiment and employment has been bad news for the U.S. Fed as they are not seeing evidence that aggressive rate hikes are having the intended impacts in slowing growth and reining in inflation. Markets had started the year positively on signs of peaking central bank tightening, however, the positive sentiment quickly faded as expectations for the path of future rates hikes jumped in response to the hotter data. Over the course of February, the futures market went from projecting the Fed Funds Rate to peak at 4.90% in June, to a projected peak of 5.41% in October. Having already raised rates by 450 basis points over the past year, the Fed is hopeful that the lagged effects will help them reach their inflation target of close to 2%, but if the economic data keeps coming in strong, the Fed may find it too hot to handle and need to step up the tightening. The months ahead are likely to be volatile as every bit of data will be scrutinized by investors hoping for just enough bad economic data to please Fed officials, yet not bad enough to signal a hard landing is imminent.
Fed Funds Rate Expectations Have Adjusted Higher
As of 28 February 2023
Past performance is not a reliable indicator of future performance.
Source: Bloomberg L.P.
Figures shown in USD.
Last One Standing
Bank of Japan (BoJ) Governor Kuroda is set to step down in early April after a decade in office with markets speculating that ultra-easy monetary policies he oversaw may be ending. The bank had already surprised markets when it eased yield curve controls at the end of last year allowing rates to rise more. With inflation running near 4.3%, a 40-year high, the BoJ has been the last major central bank standing firm with ultra-easy policy while almost all others pivoted to aggressive rate hikes to fend off high inflation. With his expected replacement, Kazuo Ueda, coming into office amid high inflation it is likely he will begin to take further steps to unwind ultra-easy policy. While stocks and bonds have broadly declined in the face of higher inflation and rates, Japanese markets may benefit as assets are repatriated back home, where they are now able to earn higher yields. For investors outside of Japan, a stronger yen supported by higher yields could provide a further boost to Japanese market returns. Although inflation has not been a friend to investors elsewhere, the Japanese market may be one area where investors welcome it.
Japan Seeing Decades-High Inflation
40 Years Ended 31 January 2023
Past performance is not a reliable indicator of future performance.
Source: Bloomberg L.P.
Figures shown in USD.
Regional Backdrop
Click each region below for more details
- Corporate and consumer balance sheets remain strong
- Labor market has been extremely resilient
- Services sector remains remarkably strong
Negatives
- Recession risk remains elevated
- Inflation has proven more persistent than expected
- Labor supply remains scarce
- China re-opening providing boost for commodity prices
- Monetary tightening may have peaked
- Labor market has been resilient
Negatives
- Recession risk remains elevated
- Housing market continues to weaken rapidly
- Consumer savings balances are fading sharply
- Unusually warm winter has driven energy costs lower
- Fiscal spending is rising
- Equity valuations remain attractive, despite recent rally
Negatives
- Inflation remains elevated, particularly core inflation
- Monetary policy remains restrictive
- Heightened geopolitical uncertainty due to the war in Ukraine
- Energy cap benefitting household finances
- Inflation expectations have reverted to normal
- UK labor market remains resilient
Negatives
- Bank of England may be forced to hike more than expected
- Fiscal consolidation may weigh further on demand in 2023
- Recession and house price declines in 2023 appear likely
- Equity valuations remain very attractive
- Gradual monetary policy normalization
- Lower commodity prices and a stronger Japanese yen are lowering the inflation impulse
Negatives
- Expectations in earnings are prone for disappointment
- Accelerating wage growth is making a gradual normalization off monetary policy difficult
- Stronger Japanese yen may weigh on the export sector
- China re-opening has boosted earnings expectations
- Domestic bonds offering attractive yields
- Economy remains broadly resilient
Negatives
- Consumer spending is at risk with mortgage rates being reset
- Latest earning results highlight concerns on margins going forward
- Reserve Bank of Australia remains hawkish
- China re-opening has proven to be faster than expected
- Equity valuations are attractive relative to the U.S.
- Earnings growth expectations are improving
Negatives
- Given the strength of the re-opening thus far, Chinese policy may become less supportive
- Geopolitical risks remain elevated
Asset Allocation Positioning
These views are informed by a subjective assessment of the relative attractiveness of asset classes and subclasses over a 6- to 18-month horizon.
Asset Classes
Near-term outlook has improved given the resilient labor market and positive developments in Europe and China. However, stocks remain vulnerable over the medium term amid tightening liquidity and an active Fed.
Persistently elevated inflation should keep global central banks in tightening mode. Credit sectors, such as high yield, continue to offer attractive yields and fair spreads with broadly supportive fundamentals.
Cash currently offers attractive yields, a shorter duration profile as rates drift higher, and provides liquidity should market opportunities arise.
Equities
Regions
Near-term outlook improved given US consumer strength and the resilient labor market. However, U.S. equities remain expensive relative to the rest of the world. U.S. tech giants may be more cyclically sensitive than expected.
Valuations are attractive on a relative basis and local currencies have room to appreciate. Reopening in China and milder-than-expected winter in Europe may continue to provide support.
Valuations and currencies are attractive and central bank tightening may have peaked. Meanwhile, the medium-term outlook in China has improved with the relaxation of COVID restrictions and an increase in stimulus.
Style & Market Capitalization
Relative valuations for value stocks remain attractive while financials are benefitting from higher rates and a strong U.S. consumer, meanwhile growth stocks remain vulnerable to rising rates.
Value stocks offer attractive valuations. Cyclical risks remain a concern, but have eased recently due to the improved outlook for China and Europe. Financials should continue to benefit from higher rates.
Small-cap earnings have held up reasonably well thus far despite economic headwinds, alongside historically attractive relative valuations. Higher-quality bias is warranted.
Small-caps offer attractive valuations and should benefit from a weaker U.S. dollar. However, caution is warranted due to a potential flight to quality that could favor large-caps.
Inflation-Sensitive
Commodities offer an attractive hedge if inflation remains elevated. Energy and industrial metals prices are supported by China reopening, but commodity prices may ultimately face pressure due to global economic concerns.
Bonds
Elevated inflation and positive recent economic data could keep upward pressure on rates in the near-term, while IG corporates offer attractive valuations and supportive fundamentals.
Developed ex-US yields could remain volatile as global central banks balance elevated inflation versus slower growth.
While yield volatility could persist as central banks continue to fight elevated inflation, potentially weaker macro backdrop over the medium-term could provide a tailwind for longer duration bonds.
Although inflation is proving to be more resilient, it is priced into current breakeven levels, limiting further upside for the sector.
Credit fundamentals remain supportive, however default rates may rise from historically low levels given a challenging economic backdrop. Higher yields offer attractive income and a buffer should credit spreads widen.
Valuations remain attractive and loans may continue to benefit from their rate resetting feature and lower duration profile as the Fed continues on its rate hiking path.
Yields still look compelling as China reopening supports EM growth and boosts sentiment. Potentially peaking central bank tightening and moderating inflation should also be supportive.
EM currencies and local yields remain at attractive levels, as investors remain cautious of risks. The sector may also benefit from further U.S. dollar weakness.
*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
Equity
Tactical Allocation Weights
Fixed Income
Tactical Allocation Weights
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 2023 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
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