Tactical Asset Allocation for Q3/2014: ongoing economic upswing
The economic upswing is weathering Eastern Europe’s recent geopolitical turmoil, North America’s unusually cold winter, and Japan’s policy inaction, while some of the major emerging markets finally appear ready for a rebound. In this context, global inflationary risks, while modest, are being somewhat underestimated in our view. Thus, we are cutting our exposure to bonds and adding to our equity exposure by reducing our underweight in emerging market equities. Please find below the market comment by Mikio Kumada and Boris Pavlu from LGT Capital Management: - Market comment (PDF) - Foto Mikio Kumada (JPG) - Foto Boris Pavlu (JPG) For more information please contact: Roland Cecchetto; Kim Ghilardi
Communicators
+41 44 455 56 66
roland.cecchetto@communicators.ch; kim.ghilardi@communicators.ch ------------------------------------------------------- Tactical Asset Allocation for Q3/2014
The economic upswing is weathering Eastern Europe’s recent geopolitical turmoil, North America’s unusually cold winter, and Japan’s policy inaction, while some of the major emerging markets finally appear ready for a rebound. In this context, global inflationary risks, while modest, are being somewhat underestimated in our view. Thus, we are cutting our exposure to bonds and adding to our equity exposure by reducing our underweight in emerging market equities.
For the coming months, we see no need to change our main macroeconomic scenario of sufficient global growth devoid of inflationary pressures. True, the US economy had a weather-related dismal first quarter, much of Europe is still growing sluggishly, and China’s new growth trajectory is evidently flatter. Importantly, however, recent economic data and most leading indicators continue to suggest that the positive growth dynamics are still in place in most major developed economies. This is true for Japan as well. While many investors would have preferred more thunderous reform announcements, Tokyo has taken a more gradual approach. Rather than miraculously blasting away all structural problems with a single “third arrow”, Japan seems to be preparing 1000 needles to soften up a variety of sclerotic points. By definition, the success or failure of such a procedure will not become evident over-night. But for now, Japan’s fundamental data are confirming that “Abenomics” is actually working.
Investors put trust in central banks
Meanwhile, the public debt crises on both sides of the Atlantic are seen all but irrelevant by markets, as central banks are trusted to have backstopped any potential escalation. At the same time, monetary policies, although in sum still highly accommodative, have started to diverge, with the Fed likely to slowly start hiking policy interest rates sometime next year, and the ECB potentially adding more monetary and/or credit stimulus. The Bank of England may also drop its easing bias soon, as some monetary authorities in Asia and the emerging markets have already done in the face of local inflationary pressures.
Inflation may not be as well-behaved as presently believed
In our risk scenario, we see the possibility of the currently very tame global inflation to pick up a notch, owing to improving labor markets, rising capacity utilization, and abundant liquidity (although the probability that such an upward shift in price pressures would be considerable in magnitude appears rather unlikely in the near future).
Equities: improvement in Emerging Markets
In sum, the equity bull market, underpinned by improving economies, remains firmly intact. Potential signs of an ageing bull market, meanwhile, are not relevant enough at this stage. We do not believe that markets are in bubble territory, even though some markets might be heading in that direction as hitherto risk-averse and/or trend-following funds are increasingly pressured to buy into rising markets. Temporary setbacks can never be ruled out, of course, but we simply don’t see a reversal of positive trends any time soon, although corrections could certainly be triggered at some stage - for example if expectations of the first post-tapering interest rate hikes (now expected for mid-2015) were to shift closer to the present.
Indian election might have set a positive precedent
Against this background, we are further increasing our allocation to equities, by reducing our underweight in the emerging markets, and only marginally cutting our markedly overweight US position. With these EM purchases, we recognize improvements in the technical picture and fund flows regarding that region, and the fact that EM equities seem to be somewhat under-owned by now, and relatively cheap. Also, Narendra Modi’s electoral victory in India could have set a welcome precedent: while we would certainly not presume to predict the outcomes of upcoming elections (with Indonesia and Brazil being the next in line), there might be a welcome political trend toward more reform-minded political leaders in some EM - which could serve as a trigger for continued gains in that space. Overall, however, we continue to overweight the developed markets (now modestly in favor of Europe over the US and Japan), while Asia-Pacific and the EM remain positioned near neutral and underweight, respectively.
Fixed Income: rates are bound to rise modestly
Bonds performed well year-to-date, but we maintain the view that yields in the US and some other major economies are bound to rise modestly, and that corporate credit spreads are unattractive – i.e. too low. Thus, we remain underweight across our fixed in-come segments (with the exception of convertibles), and decided to further sell some of our hard-currency EM bonds in the wake of their strong performance recently (note that for the past few quarters, we had preferred hard-currency issues over their local currency counterpart as the US Federal Reserve tapered quantitative easing and emerging countries were struggling to maintain the value of their currencies).
Duration below neutral in anticipation of rising interest rates
Already underweight positions in Government Bonds and Corporate Bonds are also modestly scaled back further, rendering overall portfolio duration roughly a year short of its neutral position.
Alternative Investments: keeping a steady hand
We made no changes to our allocation in alternative asset classes, i.e. we remain neutral in Hedge Funds, Listed Private Equity and Gold, and slightly overweight in Real Estate Investment Trusts and Commodities (REITs). As always, REITs are a heterogeneous asset class, and we would not be surprised to see some profit-taking in US real estate stocks after their strong run while their Asian counterparts (with Hong Kong and Singapore mostly trading at discounts to their net asset values) may get a lift from authorities backing off a bit from the tightening biases of recent years.
Commodities near neutral, with a preference for energy
The same is true for Commodities, with our systematic scoring process favoring Energy (positive roll yields) over Agriculture (better harvest outlook), which are in turn preferred over Industrial Metals (with selective contrarian opportunities). Gold, where our positioning is neutral, ranks lowest.
New asset class added: Infrastructure Master Limited Partnerships
At the same time, we note that we started adding a new asset class, Infrastructure Master Limited Partnerships, in measured steps. The main rationale here is that this asset class, which represents energy infrastructure businesses and is comparable to the REITs industry in terms of its financial setup and purpose, offers attractive dividend yields.
Currencies: continue to prefer the USD
Our long-standing underweight in emerging market assets leads to an underweight position in the respective currencies (labelled as “OTHERS” in our allocation table). Conversely, we reaffirm the tactical overweight in the US dollar, as we continue to see it supported by the relative monetary policy outlook and economic growth dynamics.
Adding a tactical long position in GBP
In addition, we decided to implement a tactical overweight position in British Pound Sterling, as economic data is firming in the UK, and monetary support may be withdrawn sooner rather than later. The GBP has already grinded higher but still remains undervalued in our view, especially vs. the euro where futures markets expect still more (minor) interest rate cuts from the ECB. In addition, the latter certainly appears more willing to deploy so-called unconventional monetary easing than the Bank of England. We normally would have no exposure to GBP, just as we have no exposure to Japanese yen in our strategic – or “neutral” – allocation. |
