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Alessio de Longis | November 11, 2021

Tactical asset allocation update: November 2021

Alessio de Longis believes current market dynamics are consistent with expectations for a short tightening cycle and a return to the low-growth, low-inflation, post-global financial crisis (GFC) world. Our framework still points toward an expansionary regime. However, hawkish monetary policy repricing and flattening of global yield curves is a reminder of rising slowdown risks into 2022.

Macro update

Leading economic indicators continue to decelerate at a moderate pace across regions. In the United States, weakness remains concentrated in consumer sentiment surveys, while business surveys, manufacturing activity, and housing indicators remain resilient.

In the eurozone and the UK, slowing manufacturing demand expectations, rising inventories, and weak consumer confidence confirm the slowdown of the past few months.

While China’s activity is likely to remain below trend growth in the near term, the negative momentum in manufacturing and real estate surveys is dissipating, suggesting some stabilization, while monetary and credit conditions are gradually improving.

Our macro regime framework remains in an expansionary regime, with global economic activity above its long-term trend and global risk appetite improving (Figure 1a, 1b, and 2).

Figure 1a: Macro framework points to an expansionary regime, China begins its recovery

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

Figure 1b: Leading economic indicators continue to decelerate at a moderate pace across regions

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

Figure 2: Global risk appetite remains on a rising trend

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Investment Solutions research and calculations, from Jan. 1, 1992 to Oct. 31, 2021. The Global Leading Economic Indicator (LEI) is a proprietary, forward-looking measure of the growth level in the economy. A reading above (below) 100 on the Global LEI signals growth above (below) a long-term average. The Global Risk Appetite Cycle Indicator (GRACI) is a proprietary measure of the markets’ risk sentiment. A reading above (below) zero signals a positive (negative) compensation for risk-taking in global capital markets in the recent past. Past performance does not guarantee future results. For illustrative purposes only.

The repricing of monetary policy expectations in the past few weeks across both developed and emerging markets has been impressive, and it is signaling a consistent view by market participants that impending tightening cycles are likely to be front-loaded and short-lived. Rate hike expectations have increased meaningfully, triggered by above-target inflation and ongoing concerns about supply chain bottlenecks. The current policy stance of central banks is being challenged.

In the U.S., bond markets are pricing in the first hike by mid-2022, much sooner than current Federal Reserve (Fed) projections. The Bank of Canada has brought quantitative easing (QE) to a premature end, and local bond markets have front-loaded two rate hikes within a year. The Reserve Bank of Australia has effectively given up on its yield curve control strategy, allowing two-year bond yields to rise to 80 basis points (bps) compared to a policy target of 10bps.1 Hawkish repricing has occurred for European and UK yield curves as well.1

However, in a somewhat unprecedented fashion, this hawkish repricing has not led to a rise in long-term bond yields. On the contrary, yield curves have been flattening aggressively, with the long end unchanged or lower over the past few months. These dynamics are consistent with market expectations for a short-lived tightening cycle and a return to the low-growth, low-inflation, post-GFC (global financial crisis) world, where the equilibrium level of interest rates remains low.

Downward pressure on long-term bond yields is indicative of persistently large precautionary savings in the private sector. Demand for credit remains weak despite abundant credit availability and easy financial conditions. Thus far, the strong money supply growth of the past few years is channeling into financial assets rather than consumption and investments.

As shown in Figure 3, U.S. bank holdings of financial assets (mainly U.S. Treasury and agency securities) have grown by over 20% year-on-year, while loan growth is flat.2 As the fiscal impulse begins to wane in 2022, private sector demand needs to make up the slack, but evidence in the economy thus far suggests this may be a challenging transition. Global yield curves are repricing accordingly.


Figure 3: U.S. money supply channeled through bank balance sheets into bond markets rather than loan growth, as credit demand remains weak

Sources: U.S. Federal Reserve, Bloomberg L.P, as of Oct. 31, 2021. Bank balance sheets contain assets, such as reserves, loans, and securities, and liabilities, consisting of deposits and other debts owed to others.

While we remain today in an expansionary regime, these developments increase the likelihood of a cyclical peak in the near term. When global market sentiment begins to discount a deceleration in growth more broadly across both fixed income and equity markets, our framework will transition to a more defensive asset allocation stance.

Investment positioning

  • Within equities, we favour emerging markets, driven by above-trend global growth, rising risk appetite, and expensive U.S. dollar valuations, which tend to support non-U.S. earnings and equity prices over the medium term. We remain tilted in favour of (small) size and value across regions. In addition, we are tilted in favour of momentum, which currently captures value and smaller-capitalization equities, therefore concentrating risk in cyclical factors and reducing factor portfolio diversification relative to the past few years. (Figures 4 and 5)
  • 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 emerging markets debt at the expense of investment grade credit and government bonds. We favour U.S. Treasuries over other developed government bond markets given the yield advantage. (Figure 4)
  • In currency markets, we have further reduced our exposure to foreign currencies and moved to an overweight exposure to the U.S. dollar, as negative growth surprises outside the U.S. provide some near-term risk to foreign currencies despite attractive valuations. 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. In emerging markets, we favour high yielders with attractive valuations such as the Russian ruble, the Indian rupee, the Indonesian rupiah, and the Brazilian real.

Figure 4: Relative tactical asset allocation positioning

Source: Invesco Investment Solutions, Oct. 31, 2021. DM = developed markets. EM = emerging markets. FX = foreign exchange. For illustrative purposes only.

Figure 5: Tactical sector positioning

Source: Invesco Investment Solutions, Oct. 31, 2021. Sector allocations derived from factor and style allocations. For illustrative purposes only.

1 All policy pricing references as of Nov. 1, 2021.

2 Source: Federal Reserve, Assets and Liabilities of Commercial Banks in the United States – H.8, Oct. 29, 2021

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Important information

Header image: Pansfun Images / Stocksy

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.

Quantitative easing (QE) is a monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective.

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.

Diversification does not guarantee a profit or eliminate the risk of loss.

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.

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 Nov. 10, 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.