Tactical Asset Allocation - October 2023

Synopsis
Global growth expectations continue to improve, led by the US, UK, and emerging markets ex-China. Rising inflation momentum, driven by energy prices, is bringing higher real yields and a bear steepening in the yield curve. High concentration in US large caps is a risk for quality mega-cap equities in a rising rate environment.
We remain overweight portfolio risk in the Global Tactical Asset Allocation model1, favoring equities relative to fixed income, emerging markets, value, and smaller capitalizations. Overweight risky credit, neutral duration, and underweight the US dollar.
Overweight risk relative to benchmark, favoring equities over fixed income and equity sectors and styles with lower sensitivity to rising bond yields.
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
The United States continues to drive the global economy. Across our leading economic indicators, the US cycle shows the clearest signs of reacceleration, led by ongoing improvements in consumer sentiment surveys, rising new orders, and strong labor market conditions in the manufacturing sector. Housing indicators continue to show surprising resilience despite long-term mortgage rates now approaching 8%, levels last seen in 2000. The US economy moves further into an expansionary regime, with growth expected above its long-term trend. In the old continent, analogous improvements are surfacing in the United Kingdom, registering the third consecutive month of meaningful reacceleration in leading economic indicators, led by an improving inventory cycle in the manufacturing sector and rising consumer confidence. On the other hand, the eurozone continues to decelerate and remains the laggard in the industrialized world, with pronounced weakness in consumer and housing surveys and weak but stabilizing performance in the manufacturing sector. In emerging markets, we continue to register diverging economic performance between China and the rest of the emerging world. Weakness in the former is broad-based across sectors, mainly housing sales and manufacturing demand, and led by tightening in monetary conditions as indicated by decelerating money supply and credit growth. Global financial markets have posted mid-single-digit negative returns across most asset classes over the past month, led by a renewed rise in global bond yields. However, our barometer of risk appetite and market-implied global growth expectations improved modestly as riskier equity and credit markets performed relatively in line with sovereign fixed income (Figures 1 and 2).

Sources: Bloomberg L.P., Macrobond. Invesco Solutions research and calculations. Proprietary leading economic indicators of Invesco Solutions. Macro regime data as of September 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.

Sources: Bloomberg L.P., Macrobond. Invesco Solutions research and calculations. Proprietary leading economic indicators of Invesco Solutions. Macro regime data as of September 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.

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Solutions research and calculations, from Jan. 1, 1992 to September 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.
The economic resilience registered since the beginning of the summer is starting to alter the distribution of risks around inflation in the near term. The rise in oil prices per barrel from the mid-$70s in June to the mid-$90s today is now translating into higher imported inflation across regions and early signs of rising input and output costs in manufacturing business surveys across countries, including China. Our inflation momentum indicators are flagging risks of rising inflation in the near term, also confirmed by strongly inverted futures curves in oil markets (approximately 10% discount between 12-month futures and front contracts), pointing to tight inventories and risks for further price increases (Figure 3). Rising inflationary pressures indirectly confirm the improving demand picture but also increase uncertainty regarding the peak in rates. Real and nominal bond yields are likely to rise further, and the aggressive resteepening in the US Treasury yield curve – approximately 100bps in the past three months — poses a meaningful headwind to long-duration assets, including growth and quality equities. Risks of a correction in mega-cap technology / quality stocks are noteworthy when US large-cap equities exhibit all-time high concentrations in the largest stocks (Figure 4). The high and rising concentration in the equity market today is reminiscent of the price dynamics of the tech run-up of 1999-2000 and the FANG / COVID-19 stay-home basket of the summer of 2020. These historical precedents point to high mean-reversion properties in market concentration, with rising interest rates often a catalyst for such corrections.

Sources: Bloomberg L.P. data as of September 30, 2023, Invesco 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.

Sources: FTSE Russell, Invesco, as of September 30, 2023. Concentration measured as a Herfindahl–Hirschman Index. (HHI)
A HHI is a metric of concentration where individual constituent weights (in percent) are squared then summed to generate a measure of concentration. Scores range from near 0 (infinite diversification) to 10,000 (the entire observed universe consists of one firm).
Investment positioning
We implemented minimal changes to portfolio positioning this month. We maintain an overweight risk stance relative to the benchmark in the Global Tactical Allocation Model, being overweight equities relative to fixed income, favoring emerging markets, cyclical sectors, value, and smaller capitalizations with favorable momentum. We are overweight credit risk via lower quality sectors, maintain a neutral duration posture and overweight inflation-linked bonds vs. nominals on renewed inflation momentum. We maintain an underweight exposure to the US dollar (Figures 5 to 8). In particular:
- Within equities, we overweight cyclical factors with high operating leverage and a higher sensitivity to a rebound in growth expectations, such as value and smaller capitalizations, while we underweight defensive factors, such as low volatility, quality, and larger capitalizations. Similarly, we favor exposures to cyclical sectors such as financials, industrials, materials, and energy at the expense of health care, staples, utilities, and technology. From a regional perspective, we remain overweight emerging markets, supported by improving risk appetite and expectations for US dollar depreciation. We maintain a neutral stance between US and developed ex-US equities as growth momentum in Europe continues to weaken.
- In fixed income, we remain overweight in risky credit2 via high yield, bank loans and emerging markets hard currency debt, despite the recent widening in credit spreads. We expect volatility to remain subdued and credit markets to offer stable yields in a favorable macro backdrop. The case for credit assets remains limited to their income advantage over government bonds rather than capital appreciation. We have moved to an overweight exposure in inflation-linked bonds across developed markets on rising inflation momentum (Figure 3).
- In currency markets, we underweight the US dollar, as regimes of cyclical recoveries are typically accompanied by strong reflationary flows into non-US assets. However, yield differentials continue to widen in favor of the US dollar, providing headwinds to this bearish position on the greenback. Within developed markets, we favor the euro, the British pound, the Norwegian kroner, the Swedish krona, and the Singapore dollar relative to the Swiss Franc, Japanese yen, and Australian and Canadian dollars. In EM, we favor high yielders with attractive valuations, such as the Colombian peso, the Polish zloty, and the South African rand, relative to low yielding and more expensive currencies, such as the Korean won, the Mexican peso, the Thai baht, and the Chinese renminbi, but still expect these currencies to do well in a US dollar depreciation scenario.

Source: Invesco Solutions, October 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.

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

Source: Invesco Solutions, October 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.

Source: Invesco Solutions, October 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 (e.g., carry), 4) currency long-term valuations.
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.
Footnotes
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1
Benchmark is 60% MSCI All Country World Index and 40% Bloomberg Global Aggregate Index (hedged).
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2
Credit risk defined as duration times spread (DTS).