More Constructive on Global Equities: Tactical Trading Decisions for October 2022
Each month, the State Street Global Advisors’ Investment Solutions Group (ISG) meets to debate and ultimately determine a Tactical Asset Allocation (TAA) that can be used to help guide near-term investment decisions for client portfolios. By focusing on asset allocation, the ISG team seeks to exploit macro inefficiencies in the market, providing State Street clients with a tool that not only generates alpha, but also generates alpha that is distinct (i.e., uncorrelated) from stock picking and other traditional types of active management. Here we report on the team’s most recent TAA discussion.
The global economy is rapidly slowing as central banks hit the brakes on economic growth through synchronized tightening. While a range of leading inflation indicators points to a moderation ahead, we are not convinced the Federal Reserve (Fed), or other central banks, will pivot and the risks of overtightening seem considerable in our estimation. Against this backdrop, we have again lowered our global growth forecasts, particularly for next year. We now see global growth at just 2.6% in 2023, half a percentage point less than our forecast three months ago and meaningfully below trend.
The Conference Board’s Leading Economic Index for both the United States (US) and Europe have now declined for six consecutive months, which points to a further slowdown in growth. Additionally, PMIs continue to cool with JP Morgan’s Global Manufacturing PMI moving into contraction, which also signals slower growth ahead. In the US, September job report highlights resilience in the economy but does little to quell the Fed’s concerns and likely cement another 75 bp hike in November. In Europe, headline inflation hit 10%, which puts more pressure on the European Central Bank to hike rates at a time when the energy crisis threatens growth. Strong consumer and corporate fundamentals could help limit negative impacts, but sticky inflation and restrictive policy put risks to the downside.
Overall, we continue to be cautious on risk assets, as uncertainty surrounding the macro backdrop persists and elevated levels of inflation causes the Fed to stay on a hawkish path.
Figure 1: Asset Class Views Summary
Source: State Street Global Advisors, as at 10 October 2022.
Directional Trades and Risk Positioning
Investor risk aversion continued to increase late in September pushing the Market Regime Indicator (MRI) into crisis regime by the end of the month where it now resides. While implied currency volatility and spread on risky debt indicators have been consistently elevated, it was the spike in implied equity volatility that pushed the MRI into crisis regime. Equity volatility jumped in September as investors digested August’s higher than anticipated inflation report, resetting expectations for the central bank policy.
Our models have become more constructive on global equities, moving to a more neutral stance, as macro indicators improved and valuations remained strong. Sentiment however continues to be a headwind as momentum and earnings sentiment deteriorates.
Given the crisis regime, which typically indicates oversold conditions and a more neutral reading from our models, we chose to reduce our underweight position in global equities. This was also consistent with the team’s desire to take the less active risk given the uncertainty about the near-term macro backdrop. As a result, we funded the equity purchase by selling core bonds and commodities.
Our forecast for fixed income continues to be poor, driven by an expectation for higher rates as rate momentum and nominal GDP growth, compared with long bond yields, are supportive. Finally, we have seen a deterioration in our forecast for commodities. This change – combined with weaker economic conditions, and increased financing costs – drove us to challenge our long-standing active position, and reduce our position, though we remain overweight.
Relative Value Trades and Positioning
Within equity, we chose to reduce the position in US REITs, increasing the underweight to the segment in favour of US large cap equities. Price momentum for REITs has been poor as investors grapple with higher rates and lower growth, both headwinds for the sector. Earnings expectations have continued to deteriorate and further weigh on our outlook.
As mentioned within fixed income, we are forecasting a rise in rates and further curve inversion as the continued Fed hawkishness pressures rates on the front end of the curve. In addition, we are also forecasting some spread widening in both investment grade and high yield credit. As a result, we reduced exposure to intermediate and long-term US government bonds, placing the proceeds into cash.
At the sector level, there were no changes with energy, utilities and financials remaining our preferred sectors. Energy continues to exhibit strength across most factors and boasts top ratings for sentiment, price momentum and valuations. Financials benefit from attractive valuations and strong sentiment, both earnings and sales, while improvements in short-term price momentum help buoy the outlook. Utilities have experienced weaker short-term price momentum, but longer-term measures remain supportive. Elsewhere, robust sentiment indicators and positive macroeconomic factors help support the sector.
To see sample Tactical Asset Allocations and learn more about how TAA is used in portfolio construction, please contact your State Street relationship manager.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent.
The views expressed are of Investment Solutions Group as of 10 October 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All information is from State Street Global Advisors unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Past performance is not a guarantee of future results. Investing involves risk including the risk of loss of principal.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
For EMEA Distribution: The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).
There are risks associated with investing in Real Assets and the Real Assets sector, including real estate, precious metals and natural resources. Investments can be significantly affected by events relating to these industries.
Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Investing in commodities entail significant risk and is not appropriate for all investors. Commodities investing entail significant risk as commodity prices can be extremely volatile due to wide range of factors. A few such factors include overall market movements, real or perceived inflationary trends, commodity index volatility, international, economic and political changes, change in interest and currency exchange rates.
Illiquid risk/Asset investments may have difficulty in liquidating an investment position without taking a significant discount from current market value, which can be a significant problem with certain lightly traded securities.
This information is for informational purposes only, not to be construed as investment advice or a recommendation or offer to buy or sell any security. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. There are no guarantees regarding the achievement of investment objectives, target returns, portfolio construction, allocations or measurements such as alpha, tracking error, stock weightings and other information ratios. The views and strategies described may not be suitable for all investors. SSGA does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision. Investing entails risks and there can be no assurance that SSGA will achieve profits or avoid incurring losses.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.
Images of NYSE Group, Inc. are used with permission of NYSE Group, Inc. Neither NYSE Group, Inc. nor its affiliated companies sponsor, approve of or endorse the contents of this program. Neither NYSE Group, Inc. nor its affiliated companies recommend or make any representation as to possible benefits from any securities or investments.