Insight Tactical Asset Allocation – Monthly Update

Above-trend economic growth and moderating levels of risk appetite continue to warrant a diversified approach to asset allocation. Our framework suggests that the economic cycle is approaching an important juncture, with the next phase likely shaped by one of two paths: Continued resilience in corporate and economic fundamentals, supporting further upside, or softer growth as global financial conditions tighten.

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: Resilience at an important juncture

Economic growth remains resilient. Led by the US, our measure of global economic growth, based on leading economic indicators (LEI), continues to register above trend. Underlying US economic strength was validated by the Fed during the September Federal Open Market (FOMC) meeting as well, as a hike in short-term interest rates came, “at a time when the American economy appears to be strengthening.” This strength appears to be pervasive, with all measured sectors of the economy within our LEI, except measures of consumer sentiment and growth within the housing market, registering above-trend. Additionally, real-time estimates of US economic growth remain at strong levels, with the Atlanta Fed GDPNow model estimating third-quarter real gross domestic product (GDP) growth at an annualized rate of nearly 4%, which is strong relative to the history of the measurement. Above-trend readings of economic activity also extend beyond the US, as developed non-US economies follow suit, with similarities to the US including stronger readings of manufacturing activity and business surveys.

Our measures of risk appetite remain positive, however, the rate of change continues to moderate. While strong corporate earnings growth, supported by the monetization of the AI buildout, continues to provide a tailwind for equity markets, rising bond yields and tighter financial conditions have put pressure on longer-duration assets. Additionally, the risk-reward tradeoff that global multi-asset investors face has become increasingly complex. Higher bond yields continue to challenge the value proposition offered by equity markets that stand at less than 2% from all-time high levels. These dynamics, together with ongoing geopolitical risks and political uncertainty heading into the US midterm elections, in our view, justify prudent risk-taking as financial markets search for direction. As a result, our framework remains in a slowdown regime, reflecting above-trend global economic growth alongside a continued moderation in global risk appetite (Figures 1a, 1b, 1c, 2).

Geopolitical risks remain elevated and cannot be discounted as the US-Iran conflict continues to be unresolved. This lack of progress continues to have negative ramifications for energy prices, as the global benchmark for crude oil has appreciated significantly, approaching levels last seen in March. Importantly, crude oil has remained elevated for a substantial period, continuing to put cost pressures on global consumers paying for refined products including gasoline, diesel, and heating oil. As a result, inflation momentum has reaccelerated by our measures, most notably through global energy prices (Figure 3). 

Our framework suggests the economic cycle is approaching an important juncture as risks to economic growth begin to reemerge. The 25 basis-point hike by the Fed is unlikely to impede economic growth or alter the path of the current corporate earnings cycle. But signals about the future rate path and the resulting tightening of financial conditions pose risks to both economic and corporate fundamentals. Fed Chairman Kevin Warsh stated in prepared remarks, “I would be hard pressed to describe broad financial conditions as restrictive. This view was widely shared by the Committee. So we removed a dose of accommodation.” This implies that accommodation still exists and that more rate hikes could follow. Risk assets repriced as the US Treasury curve flattened and signals of early stress within sectors of the high yield corporate bond market emerged. 

The rising correlation between equities and fixed income has become a renewed topic of concern, forcing many investors to draw parallels to recent history. Additionally, real interest rates have become a key focus, with the real 10-year Treasury yield nearing 3%. The last time real rates moved this significantly was in 2022–2023, when post-pandemic inflation, rising stock-bond correlations, and negative returns across equities and fixed income led many multi-asset investors to question the role of traditional bonds. The nominal 10-year yield rose nearly 350 basis points, from January 2022 through October 2023, driven entirely by higher real yields as inflation expectations declined modestly. This repricing accompanied 12 Fed rate hikes totaling 525 basis points and coincided with negative returns for both equities and fixed income. Today’s 112 basis-point increase in the nominal 10-year yield has followed a similar pattern, reflecting roughly 100 basis points of higher real yields and a 12 basis-point rise in inflation expectations. However, the underlying backdrop differs in three important ways: 

• First, core personal consumption expenditures (PCE) inflation began this year at 2.9% and now stands at 3.0%, compared with 5.1% at the start of 2022 and 3.6% by October 2023, when real rates peaked.
• Second, the starting point of real interest rates matters. In 2022, real rates started at -1.1%, and rose to 2.5%, versus a rise from 1.9% to 2.9% year to date. This reflects a more constructive economic backdrop prior to the first Fed rate hike this year compared to 2022.
• Third, earnings expectations rose only 5.2% in 2022–2023, only partially offsetting a 17% contraction in multiples, compared to a 35% growth year to date, which has more than offset a 23% contraction in multiples (Figure 4).

The parallel to 2022–2023 is instructive but incomplete. Stronger economic momentum and historic earnings growth have enabled markets and the economy to absorb tighter financial conditions more effectively so far. Going forward, the question is how much financial tightening can occur before impeding on economic and corporate earnings growth. A continuation of current growth levels can potentially overcome tighter financial conditions, or tighter financial conditions may reach levels where growth becomes inhibited. 

Therefore, the current mix of positive and negative risks warrants portfolio diversification, with an emphasis on maintaining exposure to assets that can outperform in potential upside scenarios, while hedging growth risks. Historically, periods of above-trend but slowing growth have been associated with modestly positive returns across asset classes, and performance convergence between growth-sensitive and defensive assets. This convergence continues to shape our tactical view and is reflected in the balanced and targeted investment positioning (Figures 5 to 8).

Investment positioning 

We maintain an overall risk-neutral stance relative to the benchmark, reflecting a continued emphasis on risk management. 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 rather than cyclical acceleration.

• In equities, we maintain an overweight to defensive factors such as quality and low volatility. Defensive factors 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 select areas within information technology, health care, and consumer staples, at the expense of more cyclical areas. From a regional perspective, we maintain a moderate preference for the US relative to developed ex-US markets, and developed relative to 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 tool and a hedge against downside growth risks, with a preference for inflation-linked bonds as inflation momentum has resurfaced.
• In currency markets, we move to a neutral stance on the US dollar. Within developed markets, we remain underweight the Australian dollar, British pound, New Zealand dollar, Swedish krona, and Swiss franc, while maintaining overweight positions in the Canadian dollar, euro, 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, Taiwanese dollar, and Thai baht, funded by underweights in the Chinese renminbi, Colombian peso, Czech koruna, Mexican peso, 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.