Insight

Tactical Asset Allocation - September 2023

Tactical Asset Allocation - September 2023
Synopsis
1

Economic data, market sentiment and central banks communication confirm our recent assessment of a prevailing Goldilocks scenario in the remainder of 2023. Our framework indicates the global economy remains in a recovery regime while the US moves into expansion.

2

We overweight portfolio risk in the Global Tactical Asset Allocation model1, favoring equities relative to fixed income, emerging markets, value, smaller capitalizations, and cyclical sectors. Overweight risky credit, neutral duration and underweight the US dollar.

Overweight risk relative to benchmark as labor markets confirm likelihood of near-term Goldilocks scenario. Favor  emerging market equities, value, smaller capitalizations, and credit.

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 (i.e., equity, credit, government bonds, and alternatives), regions, factors, and risk premia.

Macro update

The global economy continues to perform consistently with the Goldilocks scenario we outlined in our latest update. Financial markets and global central banks have revised their respective assessments of near-term recession probabilities, as reflected in favorable asset returns and recent upgrades to economic outlooks. The August 2023 US jobs report paints a picture of slowly declining wage growth driven by steady increases in the labor participation rate and slower, but still healthy, employment growth. Average hourly earnings are now increasing at a year-over-year rate of 4.3%, down from a 6% peak in Q1 2022, and labor participation has steadily risen to 62.8%, a meaningful increase relative to a post-COVID average level of 61.5% in the second half of 2020. As a result, the unemployment rate has gradually risen to 3.8% from a low of 3.4%, enough to reduce wage pressures while not raising concerns of a significant shock to demand. This rebalancing in the labor market should continue for the next few quarters.

In his recent speech at the annual Jackson Hole Symposium, Federal Reserve Chair Powell confirmed and welcomed these developments in the current growth versus inflation mix, highlighting, however, the uncertainties ahead and the need for monetary policy to adjust course as needed. In particular, “…we are attentive to signs that the economy may not be cooling as expected. So far this year, GDP (gross domestic product) growth has come in above expectations, and recent readings on consumer spending have been especially robust. In addition, after decelerating sharply over the past 18 months, the housing sector is showing signs of picking back up. Additional evidence of persistently above-trend growth could put further progress on inflation at risk and could warrant further tightening of monetary policy."

Our macro indicators confirm the stability in the aggregate growth cycle, with the global leading economic indicator below its long-term trend but broadly stable and unchanged over the course of the year. Growth expectations, embedded in our barometer of global risk appetite, continue to improve on the margin, pointing to upside risk in global earnings revisions and, hence, in cyclical assets. Our framework remains in a recovery regime for the global economy, while the United States is moving into an above-trend, expansionary regime led by improvements in manufacturing orders, housing indicators, and consumer sentiment surveys (Figures 1a and 1b, Figure 2, and Figure 3). 

Figure 1a: Global macro framework remains in a recovery regime
Figure 1a: Global macro framework remains in a recovery regime

Sources: Bloomberg L.P., Macrobond. Invesco Solutions research and calculations. Proprietary leading economic indicators of Invesco Solutions. Macro regime data as of August 31, 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: US growth moves above trend, while Europe and China continue to decelerate
Figure 1b: US growth moves above trend, while Europe and China continue to decelerate

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Solutions research and calculations, from Jan. 1, 1992, to August 31, 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.

Figure 2: Market sentiment stable over the past month, still pointing to upward growth revisions
Figure 2: Market sentiment stable over the past month, still pointing to upward growth revisions

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Solutions research and calculations, from Jan. 1, 1992, to August 31, 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.

Figure 3: Forward earnings expectations have bottomed, and global risk appetite suggests potential for further upward revisions
Figure 3: Forward earnings expectations have bottomed, and global risk appetite suggests potential for further upward revisions

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Solutions research and calculations, from January 1992, to August 31, 2023. Global Earnings Revisions measure 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.

Figure 4: Negligible or declining inflation momentum across regions
Figure 4: Negligible or declining inflation momentum across regions

Sources: Bloomberg L.P. data as of August 31, 2023, Invesco Solutions calculations. The 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 expect inflation to slow at a gradual pace, as evidenced in our inflation momentum indicators across the US, eurozone, and UK (Figure 4). Overall, we expect a stable economic environment for the remainder of 2023, with low but improving growth, gradually declining inflation, and monetary policy on hold, providing a favorable backdrop for cyclical assets from a tactical allocation perspective.

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. We are overweight equities relative to fixed income, favoring emerging markets, cyclical sectors, value, and smaller capitalizations. We add momentum to US equities. We are overweight credit risk via lower quality sectors and maintain a neutral duration posture while we close the exposure to TIPS introduced last month, following a renewed decline in US 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 factor such as low volatility, quality, and larger capitalizations. We increase exposure to momentum in US equities as the US economy transitions from a recovery to an expansion. These transitions have historically seen the momentum factor assume more cyclical characteristics, providing favorable interaction effects with value and small-size characteristics. 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, credit spreads continue to tighten and volatility to decline. We remain overweight in risky credit2 via high yield, bank loans and emerging markets hard currency debt. While spreads are now well below their historical long-term averages, we expect volatility to remain subdued and credit markets to offer stable yields in a favorable macro backdrop. The case for credit assets is now more limited to their income advantage over government bonds rather than capital appreciation. Following renewed deceleration in our inflation momentum indicators, we have closed the overweight exposure to TIPS introduced last month, favoring, again, nominal government bond exposures across developed markets (Figure 4).
  • In currency markets, we underweight the US dollar, as regimes of cyclical recoveries are typically accompanied by strong reflationary flows into non-US assets. While yield differentials still support the US dollar relative to foreign currencies, expensive valuations provide headwinds to the greenback when safe-haven flows are abating. Within developed markets, we favor the euro, British pound, Norwegian kroner, Swedish krona, and 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, Polish zloty, and South African rand, relative to low yielding and more expensive currencies as the Korean won, Mexican peso, Thai baht, and Chinese renminbi, but still expect these currencies to do well in a US dollar depreciation scenario.
Figure 5: Relative tactical asset allocation positioning
Figure 5: Relative tactical asset allocation positioning

Source: Invesco Solutions, August 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 Solutions, August 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 Solutions, August 1, 2023. For illustrative purposes only. Sector allocations derived from factor and style allocations based on proprietary sector classification methodology. As of November 30, 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 Solutions, August 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.

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

  • 1

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

  • 2

    Credit risk defined as duration times spread (DTS).

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