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Alessio de Longis | October 20, 2021

Tactical asset allocation update: October 2021

Despite the weakening in global leading economic indicators, our framework still points toward an expansionary regime. Alessio de Longis believes growth expectations are likely to improve over the remainder of the year, extending this expansion by a few more months.

Macro update

Leading economic indicators continue to decelerate at a moderate pace across regions. However, the breadth of this deceleration is narrowing across parts of the economy. In the United States, weakness remains concentrated in consumer sentiment surveys, while business surveys, manufacturing activity, and housing indicators have improved in recent months. We see the gradual re-steepening in the yield curve as a positive sign in the medium term, incentivizing credit creation by the financial sector and supporting future economic growth.

In the eurozone and the UK, peaking production expectations and falling inventories suggest the rebound in the inventory cycle has run its course. Eurozone manufacturing business surveys, a key bellwether of the global cycle given the high exposure to global trade channels, continue to signal elevated activity, and are yet to presage a clear downturn in the cycle.

In Asia, deceleration in manufacturing surveys, housing indicators, and industrial production have contributed to a noticeable slowdown in growth, with business surveys for manufacturing and service sectors in China suggesting below-trend growth in the near term.

Despite this broad-based softening in economic data, our macro regime framework remains in an expansionary regime, driven by our assessment that global risk appetite remains on a rising trend despite the moderate weakness in global equity markets over the past few weeks. Based on our framework, we believe growth expectations are likely to improve over the remainder of the year, extending this expansion by a few more months (Figures 1, 2, and 3).

Figure 1: 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 Sept. 30, 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. For illustrative purposes only.

Figure 2: 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 Sept. 30, 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. For illustrative purposes only.

Figure 3: Global risk appetite remains on a rising trend despite the moderate weakness in global equity markets over the past few weeks

Sources: Bloomberg L.P., MSCI, FTSE, Barclays, JPMorgan, Invesco Investment Solutions research and calculations, from Jan. 1, 1992 to Sept. 30, 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.

On the COVID-19 front, evidence continues to suggest a decline in daily reported cases around the world. Further analysis of coronavirus effective reproductive numbers (Rt) in the U.S. indicates these trends are likely to improve further.1

Headlines from China surrounding Evergrande’s debt situation continue to feature prominently in the market narrative. Based on financial and economic exposures, we don’t expect contagion risk to spread beyond local high yield debt markets. It is noteworthy that, despite the unfavourable headlines, emerging market equities have matched the performance of developed market equities over the past two months,2 potentially suggesting that valuations are already reflecting some of the long-standing concerns around China’s overextended real estate sector, regulatory interventions, and slower growth targets.

Finally, as discussed last month, while inflation is likely to remain well above target in the next few quarters, we believe it has peaked and should gradually decline back to its long-term average. This view is also consistent with central banks’ projections and consensus expectations from economic forecasters.

The bottom line is that our macro framework still points toward a positive backdrop for equities, cyclical assets, and emerging markets.

Investment positioning

  • Within equities, we favour emerging markets, driven by above-trend global growth, rising risk appetite, and medium-term U.S. dollar depreciation to support the asset class. 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. (Figure 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 reduced our overweight exposure to foreign currencies in light of negative growth surprises in developed markets outside the U.S. While valuations still point toward a long-term U.S. dollar depreciation cycle, recent underperformance in growth outside the U.S., relative to expectations, mitigates the near-term potential for foreign currency strength. 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, and the Indonesian rupiah.

Figure 4: Relative tactical asset allocation positioning

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

Figure 5: Tactical sector positioning

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

1 Source: Research from www.CovidEstim.org. Rt= effective reproductive number of the coronavirus. Rt represents the average number of people likely to be infected by each infected individual on day t. When Rt < 1, expected cases are likely to decrease in the near future.

2 Source: Bloomberg L.P. as of Sept. 30, 2021. Emerging markets refers to the MSCI Emerging Markets Index and DM refers to the MSCI World Index. Past performance does not guarantee future results.

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Important information

Header image: Rein Cheng / 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.

The MSCI All Country World Index is an unmanaged index considered representative of large- and mid-cap stocks across developed and emerging markets.

The MSCI Emerging Markets Index captures large- and mid-cap representation across 26 Emerging Markets (EM) countries. With 1,198 constituents, the index covers approximately 85% of the free-float-adjusted market capitalization in each country.

The MSCI World Index is an unmanaged index considered representative of stocks of developed countries.

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.

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

The opinions referenced above are those of the author as of Oct. 19, 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.