Multi-Asset Outlook — With growth and policy, which matters more: Level or change?
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By: Daniel Cook, CFA, Investment Strategy Analyst; Nanette Abuhoff Jacobson, Global Investment and Multi-Asset Strategist
Key points
- The level of growth and the level of policy support remain supportive but have declined marginally, leaving us pro-risk still but less so.
- Within equities, we prefer Europe, where economic fundamentals are improving and German elections may pave the way for stronger fiscal stimulus.
- Inflation pressures are likely to persist and commodities may benefit.
- Interest rates are vulnerable to higher or more persistent inflation.
- Downside risks include a spike in interest rates, COVID-related lockdowns, or a policy mistake. Upside risks include a lift in inflation-capping productivity or a broader and more sustainable reopening than expected.
The pandemic’s path remains the key to the economic outlook, and what we’ve learned about it since last quarter is concerning: Additional variants are possible (and potentially more transmissible and virulent), vaccine protection could wane over time, and a significant percentage of the population may remain unvaccinated. This new reality is reflected in reduced economic activity, the resurgence of growth stocks over value, and a return to record lows in long-maturity yields (Figure 1) . On a more positive note, growth is still strong, economies are unlikely to go back into lockdown, and stimulus remains supportive. All of this leaves markets caught between two narratives: The pace of growth seems poised to slow, but the level of growth is likely to remain above par.
Against this backdrop, we continue to seek a pro-risk stance over the next 6 − 12 months, preferring equities to bonds. But relative to last quarter, our optimism is tempered somewhat by a slight downgrade to our macro and policy outlook — including the potential for modestly slower growth, a slight reduction in policy support, and inflation that’s more persistent than the market expects. Within equities, we prefer Europe, which we continue to believe is on the cusp of economic outperformance, and we have reduced our emerging market (EM) view to neutral given the high costs of COVID, high inflation, and political volatility. We remain moderately bearish on government bonds in Europe in particular, as yields seem too low given our macro forecast. Credit spreads are generally rich, but we find some value in bank loans and EM debt.
FIGURE 1
We have been advocating value-oriented exposure from a sector, market-cap, and regional perspective. However, given the slightly less favorable fundamental and policy backdrop, we think asset allocators should be more balanced between growth and value. We continue to think commodities are supported by our inflation outlook and we favor energy and industrial metals, which have historically been more sensitive to rising inflation than equities and can potentially help hedge against a rise in interest rates.
Equities: Optimistic on Europe
We are moderately bullish on European equities due to attractive valuations, the sharp increase in vaccinations, and high savings levels, which should allow for more robust spending if consumer confidence increases as we expect. We are also optimistic that Germany’s elections this fall could lead to a more supportive fiscal environment, and one that may influence the broader European stance. While Europe has evaded Delta’s wrath better than the US thanks to higher vaccination rates, we are wary of the variant’s unpredictability and the potential for further spread on the continent.
We’ve downgraded our view on EM equities to neutral as many countries are experiencing...
