Steady Growth Our Baseline for 2022: Tactical Trading Decisions for January 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.
As we begin 2022, global economies are faced with the same set of headwinds that threatened to derail global growth in 2021. Supply chain constraints continue to linger and inflation remains elevated. The milder, but more transmittable, Omicron variant is spreading across countries and exacerbating labor shortages, which could negatively impact supply chains and further exert upward pressure on inflation.
We have been expecting economic growth to moderate but to remain above trend. Omicron will likely create a small drag in Q1, but its effects should be temporary and steady economic growth is our baseline for 2022. In 2021, global economies experienced major shocks but proved resilient and expanded on the back of a strong consumer demand. Built-up savings combined with an improving labor market will provide a solid foundation for advancement in 2022.
The December jobs report was a major disappointment but, looking below the surface, the labor market appears tight. Wage growth was robust – the number of people working part time declined and both October and November reports were revised up by a cumulative +141k. Additionally, the household report reflected strong gains and the unemployment rate now sits at 3.9%, a new post-COVID low.
A pillar of global growth, and our forecast, has been vigorous activity, as evidenced by lofty purchasing managers' indices (PMI). After having been strong for so long, it is fair to expect some moderation. But it is also important to look at the underlying factors and remember slowing is not contracting. Take the non-manufacturing ISM index, which declined 7.1 points in December. While the headline number remains at 62, well into expansion territory, new orders, new export orders, backlogs and supplier deliveries all held up above 60 as well. The manufacturing PMI index also declined, albeit at a slower pace, and sits at 58.7. While this is the lowest reading since January 2021, it remains highly elevated historically. The production component registered 59.2 while new orders hit 60.4, implying solid demand and activity levels. Activity is growth at a healthy pace.
Overall, we believe the macroeconomic environment should be supportive of growth assets.
Figure 1: Asset Class Views Summary
Source: State Street Global Advisors, as at 10 January 2022.
After capitulating in December, our Market Regime Indicator (MRI) continued to consolidate lower and is now in normal regime. The emergence of Omicron toward the end of November helped drive volatility higher, but data suggesting that the variant is relatively less severe has eased investors’ worries. Uncertainty hovers over due to elevated inflation and a more hawkish Fed, but the durable fundamental backdrop balances out the risks. Our measure for risky debt spreads finished in high risk, but implied volatility on both equities and currencies moderated considerably and ended in low risk. Overall, risk appetite has improved, and when combined with our still positive economic outlook, supports our modest overweight to growth assets.
Driven by a more supportive risk environment and firm expectations surrounding economic growth in 2022, we added some risk back into the portfolio while reducing exposure to the safe-haven assets added in December. Directionally, we eliminated our cash and gold positions while also reducing our exposure to long government bonds. Proceeds were deployed to equities and high-yield (HY) bonds.
Exceptional performance over the past few years has left equity valuations deeply negative despite strong earnings growth, but price momentum remains complementary. Additionally, expectations for economic growth and corporate profits have produced robust sentiment scores for equities within our quantitative framework.
The end-2021 melt-up in equity prices is indicative of tighter spreads for HY bonds. Further, the moderation in equity volatility implies tighter spreads while seasonality is also a tailwind for HY bonds.
Relative Value Positioning
Within equities, we continued our rotation out of the US and into non-US developed regions. In the latest rebalance, we sold US equities, both large and small caps, while increasing our Pacific equity allocation to overweight.
We are now underweight US equities, largely driven by the sizable improvement in our non-US forecasts. Price momentum remains favorable and, while having moderated, sentiment scores for the US are beneficial. However, valuations are poor and the degradation of macro scores has dulled the relative attractiveness of US equities.
Pacific equities have become more attractive in our quantitative models, owing to an improvement in sentiment scores. Pacific equities have lagged other regions — reflected in negative momentum scores. However, inexpensive valuations and advantageous macro-economic scores buoy the region.
Within fixed income, we reduced our aggregate bond holding to build our HY position, which is now overweight. While our model is looking for no change in the level or rates, HY presents a better opportunity given the improved forecast and better risk sentiment.
We made changes to both the targeted sectors and the size of our allocations. Technology remains a full allocation while financials has been upgraded from a split to full. Energy has slipped down our rankings and has been replaced by industrials, which splits an allocation with materials. Technology ranks well across all factors with sturdy price momentum and sentiment factors anchoring the sector.
Our outlook for financials has slightly improved due to better sentiment scores. Price momentum is neutral, but stout macro-economic scores strengthen our forecast. Despite rolling COVID waves, demand and economic activity remained supportive for Materials. While price momentum is negative, strong sales sentiment and attractive valuations buttress the sector. Valuations for energy are enticing, but price momentum has softened, and estimates for both sales and earnings have weakened, dropping the sector down our rankings. Industrials benefit from meaningful improvements in earnings expectations and solid balance sheets, and stand to potentially benefit from the above trend economic growth and increased capital spending by corporations.
To see sample Tactical Asset Allocations and learn more about how TAA is used in portfolio construction, please contact your State Street relationship manager.
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