Insight

Tactical Asset Allocation - May 2023

Tactical Asset Allocation
Synopsis
1

We remain positioned for a contractionary environment given low growth and declining risk appetite. Despite the resilience in recent corporate results, forward earnings revisions continue to decline steadily on a global basis. 

2

Underweight risk relative to benchmark in the Global Tactical Allocation Model1 , favoring fixed income over equities, developed markets over emerging markets, defensive sectors, and factors. We favor investment grade relative to high yield, loans, and emerging market debt

Macro update

Global risk appetite was broadly unchanged over the past month, stabilizing at levels slightly below its historical long-term average, and remains on a decelerating trend, suggesting growth expectations are likely to see further downward revisions in the near term. Similarly, leading economic indicators across most regions remain stable and below their longterm average, hence keeping our macro framework in a contraction regime for the global economy (Figure 1 and Figure 2). As discussed in recent updates, while global growth is low, it is certainly showing noticeable resilience against the backdrop of the most rapid monetary tightening cycle since the 1970s. Q1 2023 earnings season provides a useful data point to assess the current and perspective health of the corporate sector, and to evaluate how monetary and credit conditions are impacting guidance.

Figure 1a: Macro framework remains in a contraction regime
Figure 1a: Macro framework remains in a contraction regime

Sources: Bloomberg L.P., Macrobond. Invesco Investment Solutions research and calculations. Proprietary leading economic indicators of Invesco Investment Solutions. Macro regime data as of April 30, 2023. The Leading Economic Indicators (LEIs) are proprietary, forward-looking measures of the level of economic growth. The Global Risk Appetite Cycle Indicator (GRACI) is a proprietary measure of the markets’ risk sentiment. Developed markets ex-USA include the Eurozone, UK, Japan, Switzerland, Canada, Sweden, Australia. Emerging markets include Brazil, Mexico, Russia, South Africa, Taiwan, China, South Korea, India.

Figure 1b: China continues to improve, led by credit growth. Developed markets are broadly stable
Figure 1b: China continues to improve, led by credit growth. Developed markets are  broadly stable

Sources: Bloomberg L.P., Macrobond. Invesco Investment Solutions research and calculations. Proprietary leading economic indicators of Invesco Investment Solutions. Macro regime data as of April 30, 2023. The Leading Economic Indicators (LEIs) are proprietary, forward-looking measures of the level of economic growth. The Global Risk Appetite Cycle Indicator (GRACI) is a proprietary measure of the markets’ risk sentiment.

Figure 2: Market sentiment continues to deteriorate pointing to decelerating growth expectations
Figure 2: Market sentiment continues to deteriorate pointing to decelerating growth  expectations

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Investment Solutions research and calculations, from Jan. 1, 1992 to Apr. 30, 2023. The Global Leading Economic Indicator (LEI) is a proprietary, forward-looking measure of the growth level in the economy. A reading above (below) 100 on the Global LEI signals growth above (below) a long-term average. The Global Risk Appetite Cycle Indicator (GRACI) is a proprietary measure of the markets’ risk sentiment. A reading above (below) zero signals a positive (negative) compensation for risk taking in global capital markets in the recent past. Past performance does not guarantee future results.

Approximately 43% of companies have reported so far in the US, and 36% in Europe. Earnings growth has come in above consensus expectations in both regions, with positive surprises of approximately 6% and 11%, respectively. As with recent quarters, EPS projections were downgraded meaningfully ahead of reporting season, driven by recent stresses in the banking sector, providing a lower bar for positive surprises. In the US, 81% of S&P500 companies that have reported beat EPS estimates, with EPS growth flat on a y/y basis, and revenue growth at +5% y/y, surprisingly positively by 2%. In Europe, 74% of the Stoxx600 companies reporting so far beat EPS estimates, with EPS growth rising +4% y/y, and revenue growth at +7% y/y, surprising positively by 3%. In Japan, 56% of Topix companies beat EPS estimates, with still solid EPS growth at +18% y/y, and revenue growth running at +12% y/y. 

As mentioned, equity markets weakened ahead of earnings season, providing a more favorable set up for positive surprises and market outperformance which, especially for US equities, is characterized by the narrowest breadth and participation since the 1980s, with highly idiosyncratic drivers of returns. The top 2 stocks in the S&P 500 have rallied by 30% on average YTD, explaining 4.2% of the 9.2% market return over the period, and representing a record 14% weight in the index. Similarly, the top 10 largest stocks represent now approximately 29% of the index, a concentration ratio in the 96th percentile since 1980. For further context, all the market YTD return can be explained with less than 30 stocks, mainly in the growth / technology sector. This narrow leadership casts doubts on the durability and strength of the rebound.

Given our macro assessment, we remain cautions on the prospects for cyclical assets in the near term. Despite the resilience in recent corporate results, forward earnings revisions continue to decline steadily on a global basis (Figure 3), confirming a strong direct correlation with global risk appetite. Consensus EPS estimates for the S&P 500 now forecast no growth for 2023, and negative growth into next year. Highlighting once again the anomaly of this monetary policy cycle, negative forward EPS growth has historically coincided with easing monetary policy, not rising rates, likely providing headwinds for equities in the near term if inflation does not converge rapidly toward 2% (Figure 4).

Overall, the odds of a deterioration in global growth are rising. Our asset allocation framework suggests downside risks to cyclical assets are not fully priced. 

Figure 3: Forward earnings expectations continue to decline, in line with weaker investor propensity to take risk
Figure 3: Forward earnings expectations continue to decline, in line with weaker  investor propensity to take risk

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Investment Solutions research and calculations, from January 1992 to April 30, 2023. Global Earnings Revisions measures the net percentage of positive / negative revisions in 12-month forward earnings estimates. The Global Risk Appetite Cycle Indicator (GRACI) is a proprietary measure of the markets’ risk sentiment. A reading above (below) zero signals a positive (negative) compensation for risk taking in global capital markets in the recent past. Past performance does not guarantee future results.

Sources: Bloomberg L.P. data as of April 30, 2023, Invesco Investment Solutions calculations. The US Inflation Momentum Indicator (IMI) measures the change in inflation statistics on a trailing three-month basis, covering indicators across consumer and producer prices, inflation expectation surveys, import prices, wages, and energy prices. A positive (negative) reading indicates inflation has been rising (falling) on average over the past three months

We maintain a defensive positioning, with an underweight risk stance relative to benchmark in the Global Tactical Allocation Model, favoring fixed income over equities, defensive sectors and factors, and underweighting emerging market equities relative to developed markets. We underweight credit risk and overweight duration, favoring investment grade and government bonds relative to high yield, loans, and emerging market debt (Figure 5, 6, 7, 8). In particular:

  • Within equities we favor defensive factors with low operating leverage and lower exposure to economic risk such as quality and low volatility, at the expense of cyclical exposures such as value and small/mid-caps. Similarly, we favor defensive sectors such as health care, staples, utilities, and technology, at the expense of financials, industrials, materials, and energy. From a regional perspective, we continue to underweight emerging markets given the headwinds from declining risk appetite and remain neutral between the US and other developed markets.
  • In fixed income, we underweight credit risk2 and overweight duration, favoring investment grade credit and government bonds, underweighting riskier sectors such as loans, high yield, and emerging markets debt. However, income strategies remain attractive in a multi-asset context, especially relative to equities, given the higher level of real and nominal yields, and spreads at historical long-term averages. We continue to favor nominal treasuries relative to inflation-linked bonds given declining inflationary pressures.
  • In currency markets we underweight the US dollar as the greenback yield advantage over the rest of the world shrinks. Within developed market currencies we favor the euro, the British pound, Norwegian kroner, and Swedish krona relative to the Swiss Franc, Japanese yen, Australian and Canadian dollars. In EM we favor high yielders with attractive valuations as the Colombian peso and Brazilian real, relative to low yielding currencies as the Korean won and Chinese renminbi.
Figure 5: Relative tactical asset allocation positioning
Figure 5: Relative tactical asset allocation positioning

Source: Invesco Investment Solutions, May 1, 2023. DM = developed markets. EM = emerging markets. Non-USD FX refers to foreign exchange exposure as represented by the currency composition of the MSCI ACWI Index. For illustrative purposes only

Figure 6: Tactical factor positioning
Figure 6: Tactical factor positioning

Source: Invesco Investment Solutions, May 1, 2023. For illustrative purposes only. Neutral refers to an equally weighted factor portfolio.

Figure 7: Tactical sector positioning
Figure 7: Tactical sector positioning

Source: Invesco Investment Solutions, May 1, 2023. For illustrative purposes only. Sector allocations derived from factor and style allocations based on proprietary sector classification methodology. As of November 30th, 2022, Cyclicals: energy, financials, industrials, materials; Defensives: consumer staples, health care, information technology, real estate, utilities; Neutral: consumer discretionary and communication services.

Figure 8: Tactical currency positioning
Figure 8: Tactical currency positioning

Source: Invesco Investment Solutions, May 1, 2023. For illustrative purposes only. Currency allocation process considers four drivers of foreign exchange markets: 1) US monetary policy relative to the rest of the world, 2) global growth relative to consensus expectations, 3) currency yields (i.e., carry), 4) currency long-term valuations

FOOTNOTES

  • 1

    Benchmark is 60% MSCI All Country World Index and 40% Bloomberg Global Aggregate Index (Hedged).

  • 2

    Credit risk measured as DTS (duration times spread).

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