Invesco Canada blog

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Alessio de Longis | March 3, 2021

Tactical asset allocation update: February 2021

Macro update

We expect the global cycle to move into an expansionary regime, with growth above its long-term trend and continuing to improve. Our leading economic indicators continue to improve across regions despite the meaningful increase in COVID-19 infections and more stringent restrictions on mobility in some parts of the world. Improving growth momentum is most evident in the U.S., now in an expansion regime, while developed markets outside the U.S. continue to lag in the speed of recovery given mobility restrictions in the eurozone and the UK. While consumer sentiment and spending in the developed world have been somewhat impacted by restrictions over the past couple of months, capex spending, manufacturing orders, and international trade have improved. In emerging markets, our leading economic indicators are signaling that Asian economies are slowing and settling around their long-term trend growth rate while the growth momentum is picking up in the rest of the emerging world.

This is not a surprising development from our perspective given that Asia led the global recovery after the first wave of COVID -19 infections. Market sentiment continues to improve, as evidenced by the broad-based outperformance in risky assets across geographies and sectors, signaling improving growth expectations (Figure 1).

Figure 1: The global cycle moves to expansion, with improvements across the developed world, led recently by stronger momentum in the U.S., while emerging Asia settles around trend growth

Sources: Bloomberg L.P., Macrobond. Invesco Investment Solutions research and calculations. Proprietary leading economic indicators of Invesco Investment Solutions. Macro regime data as of Jan. 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.

Investment positioning

We believe the macro backdrop remains supportive for equity and credit premia, cyclical factors, and risk assets more broadly. As the economy moves to an expansion phase, we expect equities to benefit from improving earnings and to take the lead in terms of total return potential as spreads on lower-quality, risky credit have compressed below historical averages. This is consistent with historical cycles. In particular:

  • Within equities, we continue to favour emerging markets and developed markets outside the U.S., driven by improving risk appetite, attractive valuations, and a supportive global cycle. We continue to foresee a weakening U.S. dollar trend, historically supportive for emerging markets via capital inflows and easing of financial conditions. We remain tilted in favour of (small) size, value, and momentum factors. Despite the typically negative correlation between momentum and the former two factors, we expect the transient nature of momentum to gradually shift toward a more balanced composition, less dominated by mega-cap, quality stocks, and reflecting the recent outperformance in smaller-capitalization,1 value-oriented equities
  • In fixed income, we remain constructive on risky credit despite the compression in spreads. While the total return potential on credit assets has clearly diminished given lower yields, as the cycle moves from recovery to expansion financial markets volatility tends to decline, turning the investment case for credit from capital appreciation (i.e., spread compression) to income generation. We are overweight U.S. high yield, bank loans, and emerging markets debt, local, and hard currency, at the expense of investment grade corporate credit and government bonds. We favour U.S. Treasuries over other developed government bond markets. Overall, we are overweight credit risk2 and underweight duration versus the benchmark, expecting yields to rise and the curve to steepen in an orderly fashion, similarly to what we experienced in the past six months.
  • In currency markets, we maintain an overweight exposure to foreign currencies, positioning for long-term U.S. dollar depreciation. Within developed markets we favour the Euro, Canadian dollar, Singapore dollar, and Norwegian kroner, while we underweight the British pound, Swiss franc, and Australian dollar. In emerging markets, we favour the Indian rupee, Indonesian rupiah, Russian ruble, and Colombian peso. We expect the emerging markets foreign exchange carry trade to play “catch-up” sometime in 2021, having lagged in performance compared to most recovery trades in 2020.

Figure 2:  Expansion results in a shift towards equities and a reduced overweight to cyclicals and credit 

Source: Invesco Investment Solutions, Jan. 31, 2021. For illustrative purposes only

1 Source: Bloomberg L.P. performance referenced reflects the Russell 2000 index versus the Russell 1000 index from the period Oct. 31, 2020 to Jan. 30, 2021.

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

Important Information

Header image: Joshua Rawson Harris / Unsplash

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.

The Russell 1000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of large-cap stocks.

The Russell 2000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of small-cap stocks.

Capital spending (or capital expenditures, or capex) is the use of company funds to acquire or upgrade physical assets such as property, industrial buildings or equipment.

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 Feb. 28, 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.