Asset allocation – September 2018

10 Sep 2018

SUMMARY:

  • US equities continued to outperform other markets such as EMU and EM equities. This partly reflects the divergence between the US economy -which is supported by fiscal expansion and a patient Federal Reserve- and relatively weaker growth in the eurozone and EM.
  • But there is more to this divergence than faster US economic growth. The US equity rally has been led by the IT sector. This has accounted for 20%-50% of US equity returns since 2016. The rally is now looking stretched on various metrics.
  • The other salient development in August was renewed stress in emerging markets (EM). A combination of economic stress in Turkey, weaker growth in China, Sino-US trade tensions and a stronger US dollar hurt EM assets.
  • We believe there is value in EM assets, but the obvious circuit-breakers are still absent: a weaker USD, aggressive China stimulus and fresh Sino-US trade talks. EM assets prospects have soured and protectionism and tighter liquidity continue to cloud their longer-term prospects.

ASSET ALLOCATION:

Our long-held view – being long equities and underweight fixed income, notably in the eurozone – remains in place, but we reduced our risk exposure in the past few weeks. In particular, we have made the following adjustments to our asset allocation:

  • We increased our underweight in EMU government bonds, taking advantage of low German yields.
  • We went short US IT stocks versus long US equities, and we took profits on our long US banks position.
  • We closed our long EM equities versus US equities position, and reduced our long EM local debt exposure.
  • We went long a 50/50 basket of JPY and USD versus EUR as a hedge against negative global shocks.
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