Insight

Quarterly Global Asset Allocation Portfolio Outlook | Q4 2023

Quarterly Global Asset Allocation Portfolio Outlook | Q4 2023
Key takeaways
1

The global economy is decelerating but cyclical assets1 are behaving as though they’re accelerating.

2

Bank loans are introduced into our model and we also think government bonds could do well as rates fall.

3

We favour emerging markets across most asset categories, which boosts the riskiness of our stance.

Introducing bank loans

We expect the global economy to continue decelerating, while recent asset behaviour is what we would expect with acceleration. Consequently, we remain cautious, expecting a period of consolidation among cyclical assets.

Within our Model Asset Allocation we reduce high yield (HY) to Neutral, while adding to government bonds (still Underweight) and introducing bank loans at Overweight. The conservative stance is balanced by maintaining a regional bias towards emerging market (EM) assets.

We introduce bank loans to the Model Asset Allocation at an Overweight 6% (versus Neutral 4%). We view bank loans as somewhere between cash (with near zero duration) and HY (with default risk). The asset class may normally be expected to underperform HY once central banks cut rates but we find the valuation comparison to favour bank loans at the moment. 

Bank loans are assets that were originally provided by banks to companies or other entities (they are often now arranged as part of a specific syndication process). 
 

Underpinning our projections for the next 12 months are the following assumptions:

  • Global GDP growth will slow and then recover
  • Global inflation will fall but remain above many central bank targets
  • Major western central banks are approaching the end of their tightening cycles
  • Long-term government yields will be mixed; yield curves steepen during 2024
  • Credit spreads widen in the US but are mixed in Europe and defaults rise
  • Bank loan spreads are stable but defaults rise
  • Equity and REIT dividend growth moderates and yield movements are mixed
  • Commodities struggle as the global economy slows (except agricultural products)
  • USD weakens as Fed tightening ends
     

HY spreads have narrowed again, which we find odd at a time of economic slowdown. We expect spreads to rewiden and defaults to rise, on top of which we note that HY tends to underperform other fixed income assets when the US Federal Reserve starts to ease, or cut interest rates.

At the same time, we add to government bonds (going from 20% to 22%), though remain Underweight versus Neutral 25%. Yields have risen over the last three months and we note that government bonds tend to perform relatively well when the Fed starts to ease. 

Figure 1. Optimised allocations for global assets (using local currency returns)

        Optimisations  
  Neutral Portfolio Policy Range Projected Returns Sharpe Ratio Max Return Model Asset Allocation*
Cash & Gold 5% 0-10% 0.8% 10% 6% 10%
Cash 2.5% 0-10% 3.8% 10% 6% 10%
Gold 2.5% 0-10% -2.2% 0% 0% 0%
Government Bonds 25% 10-40% 3.7% 40% 10% ↑ 22%
Corporate IG 10% 0-20% 5.8% 17% 20% 18%
Corporate HY 5% 0-10% 5.0% 0% 10% ↓ 5%
Bank Loans 4% 0-8% 8.4% 8% 8% ↑ 6%
Equities 45% 25-65% 4.6% 25% 38% 34%
Real Estate 4% 0-8% 6.5% 0% 8% 5%
Commodities 2% 0-4% -2.7% 0% 0% 0%

Source: Invesco Global Market Strategy office. This is a theoretical portfolio and is for illustrative purposes only.

Regionally, we like EM (attractive spreads), but are Neutral in the UK and Underweight in Japan and the eurozone.

We are Overweight in both the US and Europe. Real estate (REITs) may appear to have been reduced (from 10% to 5%) but that simply reflects a reduction in the Neutral allocation (from 8% to 4%) to accommodate the bank loans asset class. Hence, we remain Overweight, though we have made some regional changes (adding to Japan and the eurozone, reducing US and EM).

Our model maintains the Maximum allocation to cash (10% versus Neutral 2.5%). Central bank policy rates have continued to rise and we think cash now offers decent return potential, along with attractive diversification characteristics.

The other diversifying asset that we consider is gold. However, it has performed so well that we doubt that it can sustain a much higher price. We therefore keep it at zero. We also leave the broader commodities allocation at zero, the consequence of expected cyclical weakening and prices that we find too high in many cases. We maintain the Overweight 18% allocation to investment grade (IG), versus the Neutral 10%. We expect better returns than on either government bonds or HY. We also note that IG tends to perform relatively well when the Fed starts easing.

EM is our favourite region but we also like US and UK IG. We have not changed the equity allocation and remain Underweight with an unchanged 34% allocation. We are surprised at recent gains given slowing economies and rising bond yields.

We remain Overweight EM equities (especially China) and the big Underweight is the US (12% versus Neutral 25%). We reduce Japan to Underweight (after strong performance) and add to the eurozone (Overweight). Regionally, we favour EM assets, largely because we think they are cheap but also as a hedge in case the global economy does better than we expect. Finally, we expect yen strength and maintain a partial hedge from USD into yen.

Investment Risk

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. 

Footnotes

  • 1

    Cyclical stocks tend to be in demand when the economy is doing well. Examples include restaurants, hotel chains, airlines, car manufacturers etc.

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