Chief Investment Strategist
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We have maintained our overweight in global equities
The Citi Private Bank Global Investment Committee (GIC) maintained its asset allocation on 22 August with Global Equities at +1.5% and Global Fixed Income at -1.5%.
Last month, we reduced our allocation to non-US equities by 2.5 percentage points, largely on US-policy fears, particularly the potential for a widening trade war. With US monetary policy having tightened significantly relative to other economies and prospectively going forward, we reallocated proceeds mostly to shorter-term high quality US fixed income, but also certain longer-duration US bonds.
With minimal conviction in the emerging markets of Europe, the Middle East and Africa (EM EMEA), we reduced this allocation to deep underweight last month. (This included eliminating the small equity allocation to Turkey). In contrast, we maintained certain overweights in Asia and Latin America, where our longer-term conviction is high.
We would maintain a more selective stance in certain emerging and developed markets compared to the relatively recent past. The Fed’s shift to quantitative tightening and thus reduction of its bond holdings will gradually impact a greater number of the most marginal-quality borrowers when looking out over the next two years. US trade policy remains highly unpredictable. Nevertheless, recent movements in global markets suggest greater fear than warranted given our view of the world economic outlook.
In the past month, US equities (neutral or fully allocated) and high yield credit markets (overweight) saw robust returns. Low correlation and high dispersion in security prices is consistent with strong investor confidence in US markets. Investor positioning data also suggests a very strong consensus overweight in the US dollar.
In contrast, following the plunge in Turkey’s markets, a severe spike in correlation occurred broadly in emerging markets. This is despite Turkey’s economic and financial linkages being largely contained to the EMEA region. Among significant EM countries, Turkey also has the largest foreign financing requirement relative to foreign reserves.
While we continue to see a robust outlook for US corporate earnings gains into early 2019, non-US equities prices now significantly trail both recent and prospective earnings gains.
Country-level policy issues continue to pose risks in Europe (Italy, Turkey). Political developments in Latin America pose near-term hurdles for markets with Brazil’s presidential election in two months’ time. We believe the relief seen in Mexico’s markets as election uncertainty was lifted in the June/July period is illustrative of the commonly short-term nature of election uncertainty.
Global investors are also highly focused on China’s growth prospects apart from the US trade conflict. In China, we believe investors haven’t fully understood the extent of pending stimulus efforts to offset potential losses on the trade front. Government controlled infrastructure investment has been a sharp drag on Chinese growth of late, and appears poised to rebound sharply late in 2018.
As noted, this month we maintained our lowered, but still positive tactical risk allocations following last month’s changes driven by US trade uncertainty. The pace of global growth overall will likely remain below the very strong spurt seen at the turn of the current year.
However, we believe global growth prospects are both stronger and broader than recent market fears imply. Consequently, we would take advantage of asset price weakness in markets where the fundamental outlook is strong, and markets have been excessively fearful.