Chief Investment Strategist and Chief Economist
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We have reduced our developed-market equity allocation in the wake of last month’s Brexit vote.
Having met both before and after the UK’s 23 June referendum, the Citi Private Bank Global Investment Committee (GIC) made initial changes to its asset allocation on 30 June as the shock from the “Brexit” vote faded in markets.
Another Eurozone crisis like that of 2011 seems unlikely as a result of Brexit. However, uncertain political developments are likely to impact European economies. Investors need to consider a wider range of possible outcomes. With a higher level of expected volatility, we removed our remaining overweight in all European equities, even as we see them as attractively valued relative to European fixed income. We underweight most European sovereign bonds.
We also slightly pared back our US equity overweight. This resulted in a 1.0% reduction in developed market equities. We redeployed half of this in emerging market equities. In addition, we raised our small overweight in US Treasuries further, adding to short-term Treasuries as an alternative to cash. In all, this brought our global equity overweight from +1.0% to +0.5% and our fixed income underweight from -1.3% to -1.0%. Our cash overweight was raised from 0.3% to 0.5%.
Negative-yield bonds account for the bulk of our global fixed income underweight. Even accounting for macroeconomic risks, market volatility and a strong performance for such debt, we see more attractive investment options in a mix of high-grade US dollar corporate securities, some emerging markets debt and income-producing equities. While the Federal Reserve will merely delay its minimal tightening cycle if macro risks recede in Europe, we now see a more benign global backdrop for beaten-down emerging markets. Although we added slightly to our holdings in all three EM regions, assets closely linked to the oil bust seem best positioned to outperform in recovery. Our preference for EM is slightly stronger in fixed income, and Latin America above other regions.
The UK may experience a mild recession or significant slowdown as its important, existing trade relationships are now in question. However, we retained our neutral weighting in UK equities given the prospect of an export boost from a weaker pound and the heavy weighting of global firms in the index. Our base case for Eurozone equities points to further cyclical progress, particularly now that capital costs have been driven down by the European Central Bank (ECB). At the same time, asset prices have fallen little despite a true and lasting period of greater political uncertainty for the region. We have some concern that markets may be discounting some hope that the UK referendum will be ignored. We see this as a very low-probability outcome.