Earnings expected to remain robust, with an improved economic growth outlook

Welcome to the June edition of Inview: Monthly Global House View. In this publication we consider significant developments in the world’s markets, and discuss our key convictions and themes for the coming months.

After a pause in April, the stock market rally resumed in May. The MSCI World All Country Index rose 4.1% over the month, bringing its year-to-date gain to 9.1%. The performance of global equity markets is significant because it occurred while market participants further reduced expectations of interest rate cuts by major central banks. In fact, government bond yields remained close to 2024 highs. The upward trend in yields was more evident in Europe than in the US and this contributed to the recovery of European currencies against the US dollar; the trade weighted US dollar index lost about 1.5% in May.

Upside surprises on corporate earnings helped support stock markets and investor sentiment. Once again, technology giants led the pack, although reported earnings also exceeded expectations elsewhere, including the financial sector and Europe. Furthermore, company guidance supports the expectation that the earnings trend will remain robust in the second half of the year.

Upward revisions to expected global GDP growth also support this view. The improved outlook reflects not only the better-than-expected data for the first quarter of the year but also encouraging signs emerging from recent economic surveys, particularly in the manufacturing sector. It is not surprising that this translates into improved growth prospects especially in Europe and Asia, since here the industrial sectors have a greater relative weight than in the US.

Although the rally in the first months of the year meant that global stock market valuations looked a little more stretched, the context remains favourable for risky assets. In our opinion, a moderate overweight to equities remains advisable in a balanced portfolio, with a geographical preference for Europe, the UK and emerging Asia. Within fixed income, government bonds and high quality corporate issues are preferred, something that should help control portfolio volatility.

Asset Allocation

Global Allocation

Developed equity markets rebounded from a negative April, while emerging market returns have lagged and fixed income markets have proven more challenging. Against that background, we are allowing the allocations to move in line with market drift, marginally increasing our equity overweight while reducing the fixed income allocation to marginally below the benchmark. In addition, we propose a slight increase in cash while alternatives positioning should be reduced, although both still remain underweight.

We note that reducing the exposure to equities runs the risk of being left behind if markets continue to rise over the summer months. Volatility is expected to emerge again from September as the US presidential election approaches. Any market correction could represent an attractive buying opportunity into a potential fourth quarter rally.

Fixed Income

The 10-year US Treasury yield continues to be anchored around 4.5%. If we were to see it move higher to say 5%-5.25% over the next few months, for example in response to a higher expected terminal fed funds rate, this would be a headwind for fixed income. For now we see too much volatility in fixed income markets to raise the allocation and continue to favour rates over credit. Data on household debt has started to deteriorate, with a rise in credit card and auto loan delinquencies. Credit spreads and their interaction with delinquency data remains a point of focus on the risk side. Portfolio duration remains slightly above the benchmark at 4 years.

Equities

We are increasing our Asia ex-Japan equity allocation, taking it to a slight overweight position. This is to reflect improved macroeconomics and risk factors moving up to a neutral level for the region. The country allocation in Asia reflects a reduction in exposure to India, using strong performance over the last quarter as a reason to take some profits and move to a more neutral position. We maintain an overweight to China. To fund the Asia increase we are reducing Latin American exposure further, bringing it down to a neutral level. In the region very few sectors are showing signs of uptrend and momentum. Last month we upgraded our UK equity positioning to overweight as we have turned more positive on the economic outlook. Indeed, since then a general election was called, ending one element of uncertainty.

Alternatives

Within our alternatives exposure we maintain our underweight to commodities versus the benchmark, with the majority of our commodity exposure coming from gold. This is because the price of gold has exceeded our model’s predictions. Should gold exposure get too high within the portfolio we would suggest rebalancing back to more neutral levels, taking profits from elevated valuations. Hedge fund positioning as a whole is in line with the benchmark level, but we have moved to a more neutral view on equity market neutral managers owing to rising performance dispersion at stock, sector and factor levels, with selectivity being key.

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