Tactical Asset Allocation

Summary:

• Global growth is expanding at a rate close to its potential, with no recession in sight and US output remaining solid. Chinese stimulus has led us to slightly upgrade our 2025 Chinese growth forecast to 4.5%
• Eurozone inflation is falling fast, and we now expect interest rates to be cut more rapidly. We also anticipate an additional rate cut from the SNB in December
• Macroeconomic fundamentals remain positive for risk assets amid Chinese stimulus, better US data, and falling interest rates. However, geopolitical and US election risks urge caution
• With an improved relative value proposition in investment grade and high yield credit, we raise our exposure to both segments, taking overall fixed income exposures to overweight. In equities, we raise Japanese stocks to overweight and lower UK stocks to neutral while keeping global exposures unchanged at strategic levels. We also increase our allocation to gold.

Following the Investment Committee (IC) meetings on 15 and 16 October 2024, please find below a summary of our global views and asset allocation decisions.

Global macroeconomic outlook

Chinese authorities have stepped up efforts to shore up growth and investor sentiment with new stimulus. In September, cuts to interest rates and banks’ reserve requirements, and measures to support real estate and stock markets were announced. This was followed in October by pledges of fiscal stimulus, a capital boost for banks, and more support for local government finances and housing, which is crucial for consumer sentiment (see chart 1). We now expect an additional CNY 3 trillion (approximately USD 425 billion) of central government special bond issuance. This should support economic growth of around 4.5% in 2025, a slight upward revision from our previous estimate of 4.3%.

Meanwhile, the Federal Reserve (Fed) looks poised to pull-off the historically unusual feat of cutting interest rates in a slowing economy while avoiding recession. US inflation is close to target. Yet we see no signs of outright stress in the cooling labour market, and unemployment is still low. This supports consumer spending. We expect growth of around 2% in 2025, and additional Fed cuts towards a ‘neutral’ rate of around 3.5% by mid-2025, barring the imposition of substantial new tariffs in a second Trump administration. Our base case is another two cuts of 25 basis points (bps) at its meetings in November and December this year.

In the eurozone, inflation is falling faster than anticipated. This supports our view that the European Central Bank (ECB) overtightened interest rates in 2022-2023, given the absence of a US-style boom in demand. Eurozone growth remains anaemic, with a mild rebound in purchasing managers indices (PMI) having faded and manufacturing weak. We now foresee the ECB accelerating rate cuts, easing by 25 bps in October and December, gradually moving towards our unchanged terminal rate projection of 1.5% by the end of 2025. Meanwhile the Swiss National Bank now forecasts inflation to fall next year, and we therefore expect an additional rate cut at its next meeting in December.

Overall, global growth is close to its equilibrium levels. Normalising inflation and monetary policy should prevent a recession and prolong the balanced growth outlook.

Portfolio positioning

While the global economy is expanding at a rate close to its equilibrium, markets are reacting positively to recent macroeconomic developments, including Chinese stimulus measures, better US economic data, and global monetary policy dynamics that should increasingly support risk assets. Sovereign bond yields have risen, led by the US, as markets have priced out some rate cuts. Stock markets have gained ground, particularly in Asia amid China’s stimulus and expectations of decent growth. However, market sentiment remains stretched and investors have significantly raised equity exposures over the last few weeks. We expect market volatility to increase ahead of the key risk event of the year, the US election, and seek to strike a careful risk/reward balance in our tactical asset allocations.

The start of the Fed’s policy easing combined with positive surprises in economic data has led to a repricing of bonds. Portfolio diversification from bonds is improving, following a return to more typical asset class correlations. The rise in yields now offers an investment opportunity and are moving our credit exposure, including investment grade and high yield segments, to overweight at the expense of cash. In the US and globally, the yields available on high yield credit are far above average equity earnings yields, in spite of still-tight credit spreads against reference benchmark yields. We expect high yield levels in the credit segments to absorb potential credit spread widening in an environment of slowing but still-positive growth, while company defaults decline. We seek to reduce the risk even further by pairing high yield bonds with higher quality investment grade bonds. If interest rate volatility increases around US elections, the shorter duration of high yield bonds in turn can offer a degree of protection from interest rate risk. Overall, these adjustments will bring our fixed income allocations to overweight levels.

As global growth settles around trend levels, interest rates fall, and inflation normalises, equities should benefit. We expect strong earnings growth to drive stock market gains in the coming 12 months; consensus 2025 earnings expectations are holding up well in many markets. Yet we weigh positive macroeconomic factors against overly positive investor sentiment, elevated geopolitical risks and full valuations, particularly in the US. We therefore keep our global equity allocations at strategic levels. We expect cyclical stocks to keep outperforming defensive ones, and our preferred sectors remain materials and energy. We are also shifting our preference to more cyclical regions and raising exposures to Japanese stocks, where earnings growth is improving, and reducing UK stocks to strategic levels.

In commodities, we see further upside potential in gold, as the cyclical context turns more favourable for the metal. Gold should be further supported in the coming months by falling US real rates, a more neutral outlook for the US dollar, and geopolitical and US election uncertainties; we also expect gold ETF flows to pick-up with falling rates. Gold also benefits from structural support from central bank buying amid a drive to diversify reserves from US dollars. In this context, we have raised our 12-month price target to USD 2,900/ounce and reflect this positive outlook by raising our tactical portfolio position to overweight.

Views by asset class

Equities

• Maintain equities at strategic levels. Overweight Japan and underweight European (EMU¹) stocks
• Neutral on emerging market stocks with a preference for Taiwan and South Korea
• In sectors, we prefer materials and energy. Healthcare remains our least preferred sector

Fixed income

• We hold overall fixed income at overweight levels
• Government bonds at strategic levels, favouring Bunds over US Treasuries. Overweight investment grade and high yield credit
• Emerging market (EM) hard currency debt at neutral levels, with a preference for corporate bonds

Alternatives

• Prefer portfolio diversifying and return enhancing hedge fund strategies
• Overweight gold. Our 12-month price target is USD 2,900/oz
• Exposure to Swiss real estate in Swiss franc profiles

FX

• Neutral US dollar stance. Preference for Swiss franc and Japanese yen
• Remain cautious on the euro and sterling

^[1] Economic and Monetary Union

The Investment Committee meets on a monthly basis to reassess investment views and portfolio positioning. The meeting also discusses how best to take advantage of trends and opportunities in the market. Additionally, the meeting will convene on an ad-hoc basis in response to market developments. The committee is chaired by Global CIO Michael Strobaek.