Tactical Asset Allocation – Monthly Update

Our framework continues to suggest the global economy is in a slowdown regime, with growth above its long-term trend and decelerating. Global risk sentiment continues to balance conflicting catalysts. The pro-growth impetus stemming from the AI supercycle has driven stronger corporate earnings, which has collided with higher inflationary pressures and slowing economic growth risks due to the ongoing energy shock. As a result, we remain in a slowdown regime, maintaining an overweight to equity risk relative to fixed income. But as geopolitical risks remain elevated, we are also emphasizing diversification across and within asset classes. 

Our macro process drives tactical asset allocation decisions over a time horizon between six months and three years, on average, seeking to harvest relative value and return opportunities between asset classes (e.g., equity, credit, government bonds, and alternatives), regions, factors, and risk premia.

Macro update: Strong corporate earnings counterbalance lingering geopolitical risks

Global equity, credit, and government bond markets generated positive returns over the month. That is despite the unresolved US-Iran conflict and the continued closure of the Strait of Hormuz, which has prolonged the current energy supply shock into its fourth month. While this shock continues to keep economic and inflation risks elevated, US corporate earnings have remained resilient. With 97% of constituents reporting results, the Q1 year-over-year earnings growth for the S&P 500 Index is 28.6% — on track for the highest quarterly earnings growth rate since Q4-2021. This robust growth reflects the continued positive momentum behind the AI-adoption supercycle, with seven of eleven sectors reporting double-digit earnings growth, led by information technology and communication services.

Momentum from the AI-adoption cycle is also evident at the regional level, especially when identifying drivers of index returns. For example, more than 100% of the monthly return of the MSCI Emerging Market Index was driven by Taiwan and South Korea. Three semiconductor-related individual securities accounted for nearly two-thirds of the index’s monthly total return. In aggregate, index returns have become increasingly reliant on the continued momentum behind AI adoption and less reflective of geopolitical risks stemming from the Middle East. Taken together, although absolute returns remain positive, risk sentiment continues to decelerate, pointing to a growing risk of slower growth ahead.

Our measure of global economic growth, based on Leading Economic Indicators, continues to register above trend. Regionally, the US remains the most resilient, with multiple sectors across the economy measuring above trend. Consumer sentiment, however, deteriorated on a monthly basis as households continue to face inflationary headwinds. Other developed non-US economies, most notably the eurozone, while still above trend, have weakened further as oil-importing countries continue to face elevated inflation pressures from the ongoing energy supply shock. As a result of above-trend global economic growth alongside continued deceleration in global risk appetite, our framework remains in a slowdown regime (Figures 1a, 1b, 1c, and 2).

Our inflation momentum indicators remain positive, driven primarily by energy inputs (Figure 3). This dynamic continues to have monetary policy ramifications if higher energy prices translate into higher realized inflation, potentially challenging central bank inflation mandates. Looking ahead, the longer the US-Iran conflict remains unresolved, with the Strait of Hormuz being effectively closed, inflation risk is likely to persist as a meaningful threat to consumers and the broader economy.

Our US dollar signal has shifted from neutral to bullish, as continued deterioration in international economic surprise data and narrowing interest rate differentials provide tailwinds for the greenback. As mentioned in the previous report, oil-importing economies, particularly the eurozone, have experienced a deterioration in economic data relative to expectations, as the ongoing energy shock has asymmetrically impacted various sectors of the European economy. The gap between non-US and US short-term interest rates has converged, with inflation pressures impacting the relative attractiveness of non-US versus US short-term interest rates.

As a result of the changes to our US dollar signal, our regional equity positioning adjusts as well. A stronger US dollar is supporting a greater preference for US relative to developed market non-US, and developed market relative to emerging market equities. These regional adjustments come at a time when, in our view, downside risks in non-US equities appear to be underappreciated. For example, the ongoing energy shock combined with a potentially stronger US dollar compounds the risks to energy import-dependent economies. As mentioned above, emerging market equity performance has become increasingly contingent on the continued AI buildout. Returns are now heavily concentrated in a narrow set of countries and sectors linked to semiconductor production.

In summary, the current mix of above-trend economic growth and a positive, albeit modestly decelerating, trend in risk sentiment supports continuation of the slowdown regime. While this environment does not point to a cycle-ending contraction, the balance of risks suggests diversification remains warranted. Historically, periods of above-trend but slowing growth have been associated with modest yet positive returns across asset classes, as well as convergence in performance between growth-sensitive and defensive assets. This convergence continues to shape our tactical view and is reflected in the balanced and targeted investment positioning outlined below (Figures 5 to 8).

Investment positioning 

Within this context, we have maintained an overall risk-neutral stance relative to the benchmark, reflecting a deliberate risk-management approach rather than a shift toward a defensive, risk-off posture. This positioning is designed to preserve optionality and emphasize diversification. It allows portfolios to remain positioned for further upside while identifying relative value opportunities within asset classes. Within this framework, we remain moderately overweight equities relative to fixed income, with an emphasis on defensiveness and earnings visibility rather than cyclical acceleration.

• In equities, we overweight defensive factors such as quality and low volatility. They have historically performed well during slowdown regimes due to more stable cash flow profiles and lower sensitivity to changes in growth dynamics. At the sector level, we favor exposures with defensive characteristics and durable fundamentals, including information technology, health care, and consumer staples, at the expense of more cyclical areas. From a regional perspective, we incrementally increase our preference for the US relative to developed ex-US markets. Additionally, given the headwinds that a stronger US dollar present for emerging markets, we adjust our regional equity tilt to increasingly favor developed markets over emerging markets.
• In fixed income, we maintain a moderate underweight to overall credit risk. This reflects a balance of risks that appears less favorable for spread-based compensation than alternative sources of return within a diversified portfolio. We also maintain exposure to interest rate duration as a risk-management and growth-hedging tool. With sustained inflation momentum, we prefer inflation-linked securities over nominal Treasuries, allowing portfolios to retain sensitivity to real rate dynamics while addressing near-term inflation risks.
• In currency markets, we have moved to a bullish stance on the US dollar. While negative growth surprises outside the US continue to support the dollar’s appeal as a risk-off hedge, higher US short-term interest rates have increased its relative attractiveness from a carry perspective. Within developed markets, we remain underweight the British pound, Swiss franc, Australian dollar, New Zealand dollar, and Swedish krona, while maintaining overweight positions in the euro, Canadian dollar, Japanese yen, Norwegian krone, and Singapore dollar. Within emerging markets, we favor higher-yielding currencies with relatively attractive valuations, such as the Indian rupee, Indonesian rupiah, Malaysian ringgit, and Taiwanese dollar, funded by underweights in the Czech koruna, Hungarian forint, Mexican peso, Chinese renminbi, and South African rand.

Investment risks

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.