The global reflationary rebound that began in early 2016 remains intact, but momentum is slowing, and the upswing in the tangible economic data has generally lagged the sentiment surge, leaving room for a reality check. Against this background, we have modestly de-risked our portfolios to replenish cash reserves and be better prepared for future investment opportunities.
Below we present the result of LGT Capital Partners’ latest quarterly tactical asset allocation (TAA) review, which was concluded last Friday. The TAA represents our market assessment for the next three to six months and is expressed as our investment positioning relative to our strategic allocation (SAA), i.e. our house view for the coming years.
The global macro backdrop remains benign, with economic growth sufficient and inflation moderate. Moreover, corporate earnings are growing at a stronger than expected pace in all major regions. At the same time, some sentiment indicators may have rushed ahead too quickly, as the actual macro data has often not kept up with these implied expectations. Markets could thus be more susceptible to be reined in by reality at some point in the near future.
To some extent, this is already evident in the US, where the new administration, in office for less than half a year, has yet to deliver on the promised infrastructure investment plan and tax reform. A similar development could be due in the European Union (EU) as well, where a series of europhile election outcomes have triggered an instant collapse of the measurable EU breakup risk premia, helping bolster the already surging regional business and consumer confidence readings to new records.
While our cyclical assessment for the eurozone is clearly positive, it remains to be seen to what degree this sentiment surge will actually translate into tangible economic growth in the near future. Furthermore, inflation in the industrialized world is likely to remain subdued - if not moderate further, as the outlook for energy prices remains tepid in our view, while wage-driven inflation pressures are in their infancy at best. The inflation outlook thus accentuates the loss of the reflationary momentum in the global economy.
Last but not least, the outlook for the emerging markets (EM) continues to be positive, supported by a rebound in global trade and a softer US dollar. Beyond that, the EM space remains very diverse. On the cautious side, Brazil is going through another governance scandal, albeit one that is unlikely to weigh on other markets. China’s controlled credit tightening effort, meanwhile, comes with the risk of slamming the brakes too hard again in the near-term. On the positive side, Eastern Europe is supported by the EU upswing, India is progressing with daring reforms, while South Korea benefits from the improved global trade.
That being said, we believe that the bull market remains intact, as it is underpinned by robust fundamentals. Corporate earnings are growing at double-digit rates, debt defaults are rare or decreasing, while macro policy settings are appropriate for continued growth.
However, investor sentiment and positioning look somewhat stretched in the short-term. Despite the considerable political noise, the reflationary rally that began in early 2016 has been remarkably robust and steady. As a result, equity overweights are now commonplace and investor complacency has risen, while geopolitical tensions persist, particularly in Northeast Asia and the Middle East. We thus see the conditions for a temporary pullback during the summer in place and decided to modestly reduce our most pronounced equity overweights, i.e. our positions in Europe, Japan, and Asia-Pacific. We are keeping most of the proceeds in cash to be better prepared to buy the next meaningful dip, if and when it occurs.
We have trimmed our equity overweight somewhat by shaving off a modest part of each of our hitherto most pronounced active positions, namely Europe, Japan, and Asia-Pacific. The overall segment is still clearly above our neutral (strategic) quota. Europe and Japan continue to be more attractively rated in our assessment than the other markets, although to a somewhat lesser degree than before. The positions in the US and the EM remain unchanged. As before, we keep a clear underweight in listed private equity (LPE), where discounts to net asset values are below historic averages and thus somewhat expensive. We keep our small overweights in listed real estate (REITs) and listed infrastructure (MLPs) because of the high and relatively stable dividend yield these segments offer. Commodity producer equities are left at a small underweight - in line with our cautious view on commodities.
In sovereign debt, we kept our overall underweight and relative short duration and reduced our high yield credit (HY) position to a clear underweight. Continued spread tightening has made the HY space expensive. We find better value in EM bonds issued in local currencies and added to our existing marginally overweight position. This segment benefits from the benign global growth outlook and the softer US dollar. Relatively high real yields and undervalued currencies also offer support.
Overall, we de-risked our portfolio at the margin by taking profits in equities and high yield bonds. As a consequence, we now hold a higher cash quota which we look to deploy again should an opportunity arise.
In foreign exchange, the Swedish krona (SEK) is kept as our last remaining tactical overweight, held against the overvalued Swiss franc. We had initiated this position on relative valuation grounds and divergent central bank biases last quarter and are now reaffirming this assessment. Meanwhile, the remaining overweight in the US dollar was fully closed.
As a result of the various active positions in Asia-Pacific (excluding Japan) and the EM, the respective regional currencies (“others” in our allocation table) are now generally modestly overweight against the base currencies of the various portfolio strategies.
Note: The next edition of the LGT Beacon is scheduled for 28 June 2017.