Invesco Canada blog

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Alessio De Longis | June 15, 2021

Tactical asset allocation: June 2021

The global expansion advances further, with strong momentum in Europe and emerging markets. We are not overly concerned about rising inflation at this stage, as long as growth continues to improve.

We are overweight equities and risky credit at the expense of investment grade and government bonds. We continue to favour equity markets outside the U.S., and cyclical styles/factors such as value, small-caps, and mid-caps.

Macro update

The latest read of our macro regime framework confirms the cyclical dynamics we have highlighted since the beginning of the year. The global expansion is becoming deeper and broader, with 90% of our country-level leading economic indicators now recording an expansion regime, suggesting growth is running above trend and improving across all regions.

As in the past few months, we continue to register the strongest momentum in the eurozone and the UK, where business surveys continue to signal a strong rebound in demand which, coupled with still very low inventories, is leading to a meaningful increase in production expectations.

Noticeable increases in consumer sentiment over the past month provide confirmation that the cyclical rebound is spreading across economic sectors as vaccination efforts continue and re-opening gets underway (Figure 1).

The outperformance of equity markets over fixed income markets, and cyclical sectors over defensives, suggests global risk appetite and growth expectations continue to improve.

In our last update, we outlined our perspective on inflation and the expectation for a meaningful increase in year-over-year inflation statistics in the near term due to, among other things, base effects from the recession in Q2 2020. As discussed, we expected these developments to be largely discounted by market consensus, mitigating the potential negative market impact of “high inflation headlines.”

Indeed, the reaction of U.S. Treasuries, both nominal and inflation-protected (i.e., TIPS), has been muted despite U.S. Consumer Price Index (CPI) and Producer Price Index (PPI) data releases printing well-above economists’ consensus expectations.1 This market reaction was somewhat surprising, even to us, and may indicate that market participants have already priced in a more meaningful near-term increase in inflation compared to economic forecasters.

Figure 1: The expansion continues across regions, with strong momentum in the eurozone and the UK

Sources: Bloomberg L.P., Macrobond. Invesco Investment Solutions research and calculations. Proprietary leading economic indicators of Invesco Investment Solutions. Macro regime data as of May 31, 2021. The Leading Economic Indicators (LEIs) are proprietary, forward-looking measures of the level of economic growth. The Global Risk Appetite Cycle Indicator (GRACI) is a proprietary measure of the markets’ risk sentiment. A GRACI level above (below) zero suggests above (below) trend risk sentiment. For illustrative purposes only.

On this subject, last month, we introduced a high-frequency, composite inflation momentum indicator (IMI) we use to track medium-term inflationary pressures in the economy. This indicator remains broadly unchanged since last month and continues to signal rising inflation in the near term. We map the evolution of this inflation indicator to the different stages of the business cycle, as identified by our macro regime framework. Barring exogenous supply shocks or structural forces, changes in inflation are predominantly endogenous to the business cycle, including its monetary and fiscal drivers.

Figure 2confirms this perspective on a historical basis, where inflation is more likely to increase during a recovery and expansion phase of the cycle, peak during a slowdown, and fall during a contraction.

The macro environment of the past year has, by and large, evolved in line with this historical cyclical pattern. This reflationary environment has been reflected quite broadly in financial markets across asset classes, regions, sectors, and styles. In other words, we believe rising inflation against a backdrop of improving growth is not as concerning for global equity markets, especially under the assumption of accommodative, credible central banks.

Conversely, rising inflation in a slowdown regime, coupled with tighter monetary policy, would represent a more poisonous cocktail for equity markets, given the likely combination of rising discount rates and falling earnings expectations.

Figure 2: Inflation over the past year has, by and large, evolved in line with historical cyclical patterns

Source: Bloomberg L.P. as of May 31, 2021. Invesco Investment Solutions calculations. The U.S. Inflation Momentum Indicator (IMI) measures the change in inflation statistics on a trailing three-month basis, covering indicators across consumer and producer prices, business surveys of pricing conditions, inflation expectation surveys, house prices, import prices, wages, and energy prices. A positive (negative) reading indicates inflation has been rising (falling) on average over the past three months.

Investment positioning

We have not implemented any changes to our positioning.

  • Within equities, we favour emerging markets (EM) and developed markets outside the U.S., driven by improving global growth, rising risk appetite, and a rebound in growth momentum relative to the U.S. We remain tilted in favour of (small) size and value. In addition, we are tilted in favour of momentum, which, in line with the growth-versus-value rotation, is gradually moving away from quality and mega-cap stocks toward smaller-capitalization and value segments of the market.
  • In fixed income, we favour risky credit despite tight spreads, seeking income in a low-volatility environment. We are overweight high yield, bank loans, and EM debt at the expense of investment grade credit and government bonds. We favour U.S. Treasuries over other developed government bond markets, given the potential yield advantage.
  • In currency markets, we maintain an overweight exposure to foreign currencies, positioning for long-term U.S. dollar depreciation. We remain constructive on EM foreign exchange given attractive valuations, an improving cycle, and a favourable backdrop for capital inflows, favouring the Indian rupee, the Indonesian rupiah, the Russian ruble, and the Brazilian real. Within developed markets, we favour the euro, the yen, the Canadian dollar, the Singapore dollar, and the Norwegian kroner, while we underweight the British pound, the Swiss franc, and the Australian dollar.

Figure 3: Global cycle remains in expansion regime

Source: Invesco Investment Solutions, May 2021. DM = developed markets. EM = emerging markets. For illustrative purposes only.

1 CPI and PPI year-over-year releases printed 4.2% and 6.2% in April, versus median economic forecasts polled by Bloomberg at 3.6% and 5.8%, respectively.

2 Credit risk defined as DTS (duration times spread).

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Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or from Invesco Canada Ltd.

As illustrated in our previous research, we define the four stages of the business cycle based on the expected level and change in economic growth: recovery, when growth is below trend and accelerating; expansion, when growth is above trend and accelerating; slowdown, when growth is above trend and decelerating; and contraction, when growth is below trend and decelerating.

Size (in factor investing) represents the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered.

Value (in factor investing) applies to investments trading at discounts to similar securities, based on measures like book value, earnings or cash flow.

Momentum (in factor investing) identifies investments with positive momentum (recent strong returns) or negative momentum (recent weak returns) in order to calibrate portfolio exposure to either.

Spread represents the difference between two values or asset returns.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

Issuers of sovereign debt or the governmental authorities that control repayment may be unable or unwilling to repay principal or interest when due, and the Fund may have limited recourse in the event of default. Without debt holder approval, some governmental debtors may be able to reschedule or restructure their debt payments or declare moratoria on payments.

The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.

There is no guarantee forecasts/outlooks will come to pass.

The opinions referenced above are those of the author as of June 15, 2021. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.