Given our positive view on growth, we maintain a pro-risk tilt in our asset allocation. As the U.S. economy moves into late cycle, we are naturally more attuned to any dip in higher frequency data, but currently we see little risk of recession in the next 12 months. As a result, we remain overweight (OW) stock-bond and underweight (UW) duration—albeit with slightly lower conviction in light of the failure of inflation expectations to advance alongside other macro data.
Correlation across regional indices remains low, favoring broad diversification across global equity markets. But at the margin our most favored regions remain the eurozone and Japan, ahead of the U.S. and emerging markets, with the UK our least preferred region. In bond markets we expect yields to grind higher over the fourth quarter and see U.S. Treasuries outperforming most other sovereign markets, in particular German Bunds, which look vulnerable given the robust level of eurozone growth.
Elsewhere we remain neutral on credit, real estate and commodities, and UW cash. In a distinctly mature credit cycle, returns from credit will come from carry rather than capital appreciation; nevertheless, we expect credit to outperform government bonds even if it lags stocks. Overall, we take a pro-risk stance in our portfolios but are mindful that with the economic cycle maturing, liquidity and diversification are paramount.
Read the entire market commentary here.
In Brief:
- Summer worries over geopolitics and the slide in U.S. inflation data are amply offset by the continued and synchronized pick-up in global growth. Despite the relative maturity of the U.S. business cycle, recession risks remain muted and a combination of global earnings upgrades and loose financial conditions are supportive for stocks and other risky assets.
- Globally central banks remain in mostly dovish mood; and even with balance sheet normalization in the U.S. and tapering of quantitative easing in Europe set to start this autumn, policy around the world is still loose. Rates are set to rise, but only slowly, so we maintain a small underweight to duration together with a modest overweight to stocks— diversified across regions, with a slight preference for the eurozone and Japan. We remain neutral credit, where we expect carry, not capital growth, to provide the bulk of the returns.
- Equity returns in late cycle are typically positive unless financial conditions tighten sharply. The slow pace of rate normalization and lack of inflation pressure create a good environment for taking risk, but we remain watchful for any deterioration in data, in particular employment, business confidence and consumer lending metrics.
Review the full commentary from JP Morgan with a chart of their active allocation asset class views for the next 12- to 18-months.
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