Asset Allocation Outlook

We have upgraded our view to overweight US equities. The S&P 500 Index appears expensive when evaluated using traditional valuation metrics. However, when adjusted for declining interest rates and long-term earnings growth potential driven by AI, the index appears closer to fair value. The recent rotation within US equity markets has pushed near-term volatility higher, but we view a broadening of performance outside of large-cap technology stocks to be net-positive for our outlook. We will be watching second-quarter earnings closely for confirmation that this regime shift can be sustained.

We have downgraded our view on European equities to underweight. Leading economic  indicators for the eurozone are mixed. While the consumer remains broadly upbeat, recent PMI readings show continued softness in the manufacturing sector; from here, we see increased downside risk to European growth. While relative valuations remain attractive, we do not see a compelling near-term catalyst for European equity outperformance.

We maintain our neutral view on Japanese equities, which have experienced significant outperformance in recent quarters relative to global equities. While we view the structural case as being largely intact, higher valuations, monetary tightening by the Bank of Japan (BOJ) and a potentially stronger yen present near-term headwinds for relative performance.

We have moved our outlook for emerging markets to underweight, largely driven by a deteriorating outlook for Chinese equities. Cyclical and structural headwinds persist for Chinese assets, and we expect trade tensions with the US to weigh on the outlook into November’s US elections. In addition, continued weakness in Chinese property market data is a further headwind to any broader economic recovery.

Within our overall duration overweight view, our relative view on US rates remains neutral. The Treasury market now prices two to three rate cuts in 2024, which we view as fair value. We expect the US Federal Reserve to deliver its first rate cut in September and to take a gradual approach thereafter as inflation and labour market data evolve.

We maintain a neutral view on European government bonds within core duration. We believe disinflation across the European Union has further to go and we see less risk associated with fiscal policy and term premia; however, we view current pricing as reflective of the likely policy path from here.

We maintain a neutral view, given our expectation that the BOJ will remain patient as it looks to normalise policy. Top-line Japanese growth remains weak, and we are seeing slowing inflation. Nevertheless, we still agree with the narrative that Japan should, at some point, phase out extraordinary monetary easing.

We anticipate that spreads will likely remain range-bound, with little room for further tightening. As a result, we see little potential for capital gains, hence our neutral view in favour of high yield.

We still have an overweight view on high-yield relative to investment-grade credit. We expect high-yield debt to benefit from better overall conditions for risky assets. While spreads remain tight, total income provides a significant cushion against spread widening in the absence of a significant rise in default rates, which is not our base case.

Our view on emerging markets (EM) debt is underweight, primarily due to the expected continuation of low growth in EM economies. We see more limited opportunities for tightening across EM high yield. While the return of weak issuers to the primary market has boosted sentiment, flows have been limited. Continued strength in the US dollar remains an additional headwind for the asset class.

In energy markets, we have moderated our view to neutral as oil prices breached our near-term price target in July. Heightened geopolitical risk boosts the case for commodity exposure in a multi-asset portfolio construct; however, we await better entry levels before shifting to an overweight view.

We still have a neutral outlook on gold markets. Gold has meaningfully outperformed real rates over the recent inflationary period, which, in our view, limits further price upside from here. A punitive roll yield requires a substantive price appreciation to justify any overweight.