Asset Allocation Outlook – April 2024

We have downgraded our view on US equities from overweight to neutral. The S&P 500 Index appears expensive when evaluated using traditional valuation metrics, especially if real interest rates remain at their current higher levels. However, when adjusted for declining interest rates and long-term earnings growth driven by innovation, the index appears closer to fair value and even slightly undervalued. 

Europe continues to exhibit signs of economic weakness, even as profit margins remain near record highs. Despite some evidence of a bottoming in the macro cycle, the muted economic recovery (specifically in Germany) could lead to some earnings weakness in the coming months.

We maintain an overweight view on Japanese equities. Japan’s economy is in a favourable position, with growth, inflation and wages all performing well. The structural growth story remains strong, as evidenced by capital expenditures and business confidence.

We have upgraded our emerging markets (EM) equities outlook to neutral. Cyclical and structural headwinds persist for Chinese assets. However, earnings are starting to stabilise and valuations remain attractive. Balancing these factors, we see a wide range of potential outcomes for EM equities in this environment and lean towards a neutral stance. 

We have upgraded our US rates outlook to neutral. Market expectations of aggressive cuts have been squeezed out, and risks appear more balanced now. Wage growth and hiring continue to cool, but at a slower pace than anticipated. We think that continued disinflation and market repricing support our more positive view on duration.

We have downgraded our European rates view to neutral. We think disinflation across the European Union has further to go and see significantly less risk associated with fiscal policy and term premia. However, recent outperformance of European rates has led us to moderate our previous overweight view. 

We maintain our neutral view given our expectation that the Bank of Japan will remain patient as it looks to normalise policy. Japan has entered a technical recession, and we are seeing slowing inflation. Nevertheless, we still agree with the narrative that Japan should, at some point, phase out extraordinary monetary easing.

We are cautiously optimistic on credit spreads as conditions are becoming more favourable. We forecast a low single-digit expected return. With the expectation that the Fed will eventually cut rates, the theme of higher-for-longer rates — still so prevalent in 2023 — has started to fade, somewhat easing financial conditions.

We think high-yield debt should benefit from better overall conditions for risky assets. While spreads remain tight, all-in yields provide a significant cushion against spread widening in the absence of a major rise in default rates, which is not our base case.

We are becoming more constructive on EM debt and see value emerging in EM sovereigns; however, we remain broadly neutral. We remain wary of significant idiosyncratic risks driven by Nigeria, Egypt and Argentina (which together constitute 13.5% of the market index).

We have a neutral outlook on gold markets. Gold has meaningfully outperformed real rates over the recent inflationary period, limiting further price upside from here, in our view. A punitive roll yield requires a substantive price appreciation to justify any overweight.