What is the best asset allocation?
Global equities have partially recovered their early February losses and market volatility measures have fallen, though still at levels higher than last year. There is a constructive view on global equities as the economic backdrop remains strong and expect global inflation to pick up only gradually. This should allow central banks to normalize monetary policy at a measured pace. The ECB has dropped its pledge to increase its asset-purchase program in “size and/or duration” if needed, and it is expected to taper the program in the fourth quarter of this year.
It made sense to remain overweight global stocks versus euro high yield and high grade bonds. As we enter a phase in the business cycle where volatility tends to increase, it could be right to protect part of your pro-risk exposure through equity put options. An escalation in trade tensions remains a risk, but the base case is for a combination of targeted tariffs and bilateral negotiations, with no significant economic impact.
US companies, which make up about half of the global stock market, are benefiting from tax relief and a new fiscal spending package. By price-to-earnings ratio, the global stock valuation is slightly below long-term average. Analysts remain overweight Eurozone versus UK stocks. Given their cyclical sector composition and high operational leverage, Eurozone companies are well placed to benefit from robust global demand, while UK firms should lag other regions in terms of earnings growth.
Experts are also overweight emerging market (EM) versus Australian stocks. Like their Eurozone peers, EM companies should benefit from the strong global growth given their operational leverage, while the expected weakness in the US dollar should enhance their stock performance in USD terms. Investors who don’t own Australian stocks should underweight UK stocks. Trade disruptions would hit export-oriented Eurozone and EM companies.Analysts are overweight EM sovereign bonds in USD against high-grade bonds. We expect EM sovereign spreads to tighten amid improving fundamentals, stable commodity prices and a benign external backdrop. Also, their current yield pick-up of 2.6% in USD is attractive. Euro high yield bonds remain expensive and we continue to underweight these assets versus global equities. Analysts are overweight 10-year US Treasury bonds against USD cash, a position that should benefit from the attractive carry. By contrast, analysts are underweight 10-year Japanese government bonds against JPY cash. The Bank of Japan is likely to raise the target of its yield-curve control later this year, while an interest rate cut looks unlikely.Analysts are reducing our long CAD versus USD position, given the near-term headwinds of market volatility and trade-related uncertainty. In general, FX positions should benefit from a solid global economy that convinces investors to let go of safe-haven currencies. In addition, analysts are long EUR versus short USD, long GBP versus short CHF, long JPY versus short NZD, and overweight a diversified basket of EM currencies. The Eurozone runs a large trade surplus, at 4% of GDP, while the US has sizable trade and budget deficits, which should support the EURUSD exchange rate. Long GBP versus short CHF position should benefit from lower Brexit uncertainty, while the Bank of England is likely to hike rates at least once this year.