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Maintaining our allocation amid fast-changing valuations

Steven Wieting

By Steven Wieting

Chief Investment Strategist

February 21, 2017Posted InEquities, Investment Strategy, Investments and Fixed Income

The Citi Private Bank Global Investment Committee left its asset allocation unchanged at its 16 February 2017 meeting, overweighting US dollar assets while keeping a small tactical overweight in both cash and gold. We continue to assess investment opportunities amid fast-changing market valuations and speculation over new policies.

The allocation to global equities remains at -1.0% and fixed income -1.0%. Within this allocation, we maintained a neutral (full) allocation to US equities, an overweight to US credit and to select emerging markets fixed income. These allocations have all provided solid returns so far this year. We maintained large underweights in European and Japanese government bonds where returns have been negative thus far in 2017.

In international equities markets, we see currency depreciation hampering potential returns measured in US dollars over the next 12- 18 months. This reflects an expected diverging path for US monetary policy from other central banks, and potential US fiscal policy steps that could bear directly on exchange rates. Nonetheless, most international equity markets have rallied in the year-to-date. While we maintain full investment allocations to emerging market equities, we continue to favor those linked to the petroleum recovery over those that appear vulnerable to higher US interest rates.

European sovereign credit risks have re-emerged this year amid some populist-led election campaigns. While yields remain low, European sovereign bonds have suffered losses even as the Euro remains firm. Political outcomes could determine the outlook for European equities. Valuations remain favorable, corporate earnings are recovering, and the moderate economic recovery in the Eurozone appears entrenched. This suggests the potential for outperformance if political risks fail to materialize. However, implied volatility (on the risks to Eurozone cohesion) appears underpriced at the moment.

After the Fed raised short-term US interest rates a mere 0.5% over the course of two years, emerging Asia may also be challenged by a somewhat more conventional path of tightening by the U.S. central bank in 2017. However, the stabilization of China’s economy and its efforts toward a smooth political transition ahead of the 19th National Congress this autumn may help the region’s markets.

Latin America has continued to make progress after a multi-year collapse in commodities and currencies, and we continue to see solid opportunities in the region’s fixed income and equities. A sole performance exception has been Mexico which saw a severe currency market revaluation after the 2016 U.S. election. While political and economic risks remain, we would advise international investors to avoid underweight positions in Mexican assets with the peso now at a multi-decade inflation-adjusted low.

We continue to see long-term US yields contained by low developed market sovereign bond yields elsewhere. While US credit market valuations have risen significantly, yields remain globally appealing. Looking ahead, the GIC will weigh prospective returns for various regional equities markets after the seasonally-strong winter performance period has passed and as important details on planned U.S. fiscal reforms come to light.