Allocation Views: Accounting for animal spirits

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Animal spirits continued to drive global markets in February as investors took confidence from US President Donald Trump’s pro-growth rhetoric. However, uncertainty around the implications of US government policy alongside an uptick in geopolitical tensions has subdued risk assets despite a supportive macroeconomic outlook.

Leading indicators of growth and inflation remain positive for equities, in our analysis, highlighting healthy global growth and an ongoing disinflation trend, but the uncertain policy outlook has influenced our thinking in recent weeks, pushing us to take a more considered approach to asset allocation, while tilting toward “risk-on” in our positioning. 

Against this background, we hold a preference for US stocks amid improved corporate fundamentals, but a still-uncertain outlook for international markets curtails our overall risk appetite. Within fixed income, we prefer international bonds given a weaker macro envi­ronment outside the United States.

Macro themes

Growth remains constructive

• Leading economic indicators suggest positive global growth .
• Growth reflects ongoing strength in the services sector, while manufacturing activity has also begun to improve.
• US trade tariffs are a headwind to global growth as policy uncertainty discourages investment and limits animal spirits.

Inflation risks lessening

• Significant progress has been made, although it has been bumpy, and inflation is still above targeted levels.
• Elevated services inflation is normalizing gradually alongside labor market strength, while core goods inflation remains weak, despite recent volatility.
• Tariffs have raised short-term inflation expectations, but are more likely to cause a one-off rise in prices rather than have a sustained impact.

Divergent policy outcomes

• We expect a greater divergence of policy outcomes as the Fed recalibrates its interest-rate strategy against a strong US economic backdrop.
• Other Western central banks are set to cut rates more quickly, particularly in Europe where growth is weak.
• Fiscal policy in major economies such as the United States, Germany and China is emerging as an influential driver of asset prices.

Portfolio positioning themes

Growth supports risk assets

• The macro environment is constructive, broadly supporting strong markets.
• Global corporate fundamentals appear robust, as earnings continue to strengthen against the healthy macro backdrop.
• Elevated equity valuations, tight credit spreads and fiscal policy uncertainty represent risks to global growth.

Equities: America first

• Strong earnings growth in the United States influences our positive outlook for US equities.
• Uncertain macro conditions diminish the broad appeal of international equities relative to US stocks, despite attractive valuations.
• We retain a pessimistic view on emerging markets ex China, given global manufacturing weakness, a strong US dollar and the potential negative impact of US fiscal policy.

Convergent bond yields

• We hold a preference for global fixed income, amid falling US Treasury yields, remaining long eurozone duration while we monitor the impact of recent fiscal stimulus.
• Market expectations around the depth and duration of some policy easing cycles have retraced to more appropriate levels.
• Relatively healthy financial conditions support optimism toward corporate bonds, with a slight preference for high-yield issues.