Global Chief Investment Strategist
May 4, 2017
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Having upped our weighting in EM bonds, we expect to take further non-dollar exposure over time.
The Citi Private Bank Global Investment Committee kept its overall asset allocation unchanged at its 27 April meeting, while making shifts within Fixed Income. Global Equities remain at a full or neutral allocation, with Fixed Income 1.5% underweight. We maintain small overweights in Cash and Gold. Today, we increased local currency Emerging Market Fixed Income weightings and expect to add further to non-US dollar investment exposures over time.
The outcome of the first round of the French presidential election significantly eased fears of a populist president seeking France’s withdrawal from the Eurozone. While the consensus expected a centrist victory, European Equities still rose sharply, revealing the risks at stake. They remain favorably valued in relative terms, while an uneven regional economic recovery appears increasingly entrenched. This argues for increasing our allocation from a modest underweight. However, we see continued regional political and policy challenges beyond the near-term. With European Investment Grade Corporate Fixed Income yielding below 1% across all maturities, we cut this sector to underweight from neutral. We also somewhat reduced our overweight in European High Yield Fixed Income.
We maintain large underweights in European and Japanese Sovereign Fixed Income, where a sizeable proportion of securities still have negative yields. After a significant period of outperformance thanks to rising oil prices and falling nominal yields, we reduced our weighting in inflation-linked US Treasuries to neutral from overweight.
With these reductions, we boosted our overweight in local currency Emerging Market (EM) Fixed Income to 1.0%, roughly matching our overweight in EM equities. We increased allocations to all regions, with bonds favored in Brazil, Mexico, Russia, India, Indonesia and China.
Fears that US policies will disrupt the global economy and markets this year have diminished. This is partly due to the predictably slow progress on US tax policy changes and internal Republican Party conflicts over budgetary issues. It also stems from the US administration’s seemingly more co-operative stance towards reaching international trade accords. However, US policy fears could revive periodically, particularly as the Federal Reserve plans both to raise short-term rates and gradually to begin reducing bond holdings.
As a monetary policy tool, the Fed’s balance sheet is far from insignificant. However, we expect the Fed to continue a historically modest tightening cycle, much smaller in scope than the central bank’s massive easing steps between 2008 and 2014.
With the trade-weighted US dollar rising one-third in value over the last six years – erasing more than half of international equity returns when expressed in US dollars – we expect stronger-long-term returns in international equities, which trade at a valuation discount to those in the US. The extended nature of the current economic cycle keeps us from holding a very large overweight in Global Equities, although we favor the asset class over Fixed Income, and may raise allocations.
We remain fully allocated to US Equities despite above average valuations. Large-cap US earnings are poised to rise more than 10% in 2017’s first quarter, and we expect EPS gains to ease valuation concerns and set the direction of equity prices this year. A customary summer swoon in Global Equities could offer good entry points.