Global Asset Allocation Views 4Q 2022
Insights and implications from the Multi-Asset Solutions Strategy Summit
- Our base case sees subtrend global growth in 2023, with recession in Europe and the UK. The U.S. may yet narrowly avoid recession next year; nevertheless we expect sharp falls in goods markets, inventories, and earnings.
- Inflation is sticky in most regions, prompting rapid tightening in monetary policy. Global central banks look set to keep financial conditions restrictive in 2023 even as growth slows.
- We are neutral duration and overweight cash in our multi-asset portfolios. U.S. bond yields may be nearing the top of their range, but other G4 yields have further to go, while cash rates in all regions are increasingly attractive.
- We are underweight equities, as we expect meaningful downgrades to earnings globally, with our underweights broadly spread. In credit we are neutral overall, but with a clear preference for investment grade over high yield.
This September has been nothing if not volatile. As the summer’s warmth began to fade, so too did hopes of a policy pivot and a soft landing, which had buoyed markets in July.
What lies ahead is, at best, a period of subtrend growth extending well into next year and a substantial risk that the global economy slides into recession. This may be the best-telegraphed economic slowdown in history. Still, neither the labor market nor corporate earnings seem to have received the memo: U.S. unemployment stands at just 3.7%, and despite a slump in other high frequency data, consensus forecasts still call for earnings to grow this year and next.
As the projections from the September Federal Open Market Committee (FOMC) meeting make clear, policymakers are fully committed to reducing inflation even if it takes a toll on growth, and rates will remain elevated throughout next year. Should asset markets begin to discount a premature pause in rate hikes, threatening to undo policymakers’ efforts to tighten financial conditions, it would simply force central banks to double down. Realistically, the only way this hiking cycle ends or reverses early is with a sharp collapse into recession – hardly a reassuring backdrop for contrarian bulls.
Over the next 12 months, our core view anticipates sluggish growth in the U.S. and recession in Europe. Even if the U.S. economy avoids an outright recession, the damage would be palpable: a sharp inventory contraction, recession in some parts of the goods market, and a significant earnings decline.
While we see core inflation falling to around 3% by this time next year, we note that such a level would still be above central bank targets, and the risks are tilted to inflation remaining high. Services inflation seems sticky, stoked by a tight labor market. Even with growth precarious at best, this backdrop does not point to a swift loosening of monetary policy.
Positioning in our multi-asset portfolios reflects these tensions. We are positioned cautiously, like our fixed income colleagues, but we see limited risk that U.S. policy rates rise much above 4.5%. We see the same risk to earnings as our colleagues in equities but fear that valuations will struggle to absorb the worst of the downgrades ahead, leading stocks to new cycle lows.
We maintain an underweight to equities, neutral views on credit and duration, and an overweight to cash. Crucially, our conviction in this cautious stance is increasing. And given our view that the market’s focus is shifting from inflation to growth, the direction of travel in our neutral call on duration is toward adding at yield levels not far north of here.
Within equities, we prefer to spread our underweight across regions. U.S. stocks are higher quality but still expensive; European stocks are exposed to major event risk but cheap. Emerging market (EM) equities have already seen severe earnings downgrades, but USD – central to the EM outlook – looks set to remain supported even if it seems past its peak for the cycle. Japan alone warrants a more neutral stance, with the weakness in the yen supporting Japanese earnings even as global growth slows. Otherwise, both our value- and our growth-tilted managers are taking a distinct up-in-quality bias, which is introducing further defensive characteristics across our equity exposures.
Within our neutral view on credit, we strongly favor investment grade (IG) over high yield (HY). Certainly, levels of all-in yield mean that for portfolios with an income objective, higher quality credit is becoming more attractive. But if we are right that equities have yet to see their cycle lows, then credit spreads are set to widen further, even if defaults remain contained. Overall, we have yet to reach the point where it makes sense to add risk in speculative grade credit.
We maintain a neutral duration view, with a preference for U.S. Treasuries over other G4 sovereign bonds. German Bunds appear particularly vulnerable to more hawkish policy in the eurozone. Should growth concerns begin to dominate in the months ahead, we would expect to see a strong bid for duration. For now – with policy rates on the rise – we prefer to keep an overweight to cash.
On balance, our portfolios are little changed from the cautious stance that we articulated in June. However, our conviction in an earnings downgrade cycle and weaker growth – tested over mid-summer – has increased. Cautious positioning demands that we be mindful of bear market rallies. But the key risks we are monitoring continue to be persistence of inflation, consumer weakness, central banks over-shooting tightening, and geopolitics – any of which could push the global economy more deeply into recession.
Multi-Asset Solutions Key Insights & “Big Ideas”
The Key Insights and “Big Ideas” are discussed in depth at our Strategy Summit and collectively reflect the core views of the portfolio managers and research teams within Multi-Asset Solutions. They represent the common perspectives we come back to and regularly retest in all our asset allocation discussions. We use these “Big Ideas” as a way of sense-checking our portfolio tilts and ensuring they are reflected in all of our portfolios.
Active allocation views
These asset class views apply to a 12- to 18-month horizon. Up/down arrows indicate a positive (▲) or negative (▼) change in view since the prior quarterly Strategy Summit. These views should not be construed as a recommended portfolio. This summary of our individual asset class views indicates strength of conviction and relative preferences across a broad-based range of assets but is independent of portfolio construction considerations.