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 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.
On the surface, disappointing data prints have further stoked fears of peak growth and have at points introduced anxiety into markets. However, much of the softening can be attributed to ongoing logistical bottlenecks and resurgent COVID-19 fears, which should prove to be transitory. Some moderation in economic growth ought to be expected as it is difficult to maintain the torrid pace that we have witnessed so far. The pace of corporate earnings improvements will slow but should remain healthy. Similarly, monetary and fiscal policy will become marginally less favorable, but households should be able to draw on accumulated savings.
Despite these near-term headwinds, the underlying fundamentals remain firm and we continue to expect positive economic growth. Service sector activity continues to exhibit strength, and even though the recent purchasing managers' index numbers have slipped, they remain above the expansionary 60 level for a record sixth consecutive month. Bank of America noted that the earnings story remains robust with consecutive blockbuster seasons. It was also noted that 87% of US companies delivered positive earnings surprises, the highest since 2000, while 62% of European companies exceeded expectations, the third best season on record.
Improving leading economic indicators (LEI) give reason to believe earnings will remain strong. The Conference Board’s LEI index improved again in July and remains in an uptrend, indicative of strong economic growth in the second half of the year. Central banks have begun to discuss tapering, but monetary policy will remain accommodative with rate hikes and balance sheet reductions likely to remain on hold for now. Employment figures in August were a disappointment relative to consensus estimates, but there was a large upward revision to numbers of the prior two months. It is possible that the August data will also be revised higher at some point. The unemployment rate continued to tick down, which bodes well for future economic activity. Lastly, wages have moved higher and there are indications that this trend may persist, providing a further boost to consumers.
Overall, the still favorable macroeconomic outlook and favorable quantitative forecasts reinforce our preference for risk assets (Figure 1).
Figure 1: Asset Class Views Summary
Source: State Street Global Advisors, as at 10 September 2021.
Directional Trades and Risk Positioning
Risk appetite is still supportive of growth assets as evidenced by our Market Regime Indicator (MRI), which finished August in a low risk regime. Despite concerns about moderating economic growth and the potential for the US Fed to initiate tapering, investor sentiment remained positive. Risky debt spreads narrowed during the month, while implied volatility on equities declined, moving further into low-risk territory. Implied volatility on currencies increased during the latter part of August but still reflected a sanguine risk environment.
Equities and commodities remain favored by our quantitative framework and we have preserved our sizable overweight to both. Strong sentiment and price momentum underpin our constructive equity forecast, while commodities remain supported by an advantageous curve structure. Our expectations for core bonds continue to weaken with our models now forecasting a small rise in interest rates, which reinforces our current underweight.
Relative Value Trades and Positioning
Within equities, we held our regional exposures constant, maintaining a preference for US and European equities. Strong earnings and sales sentiment combined with positive price momentum and macro scores continue to buoy US equities. Improvements in price momentum support European equities, which also benefit from strong sentiment and macro forecasts.
Within fixed income, our model forecasts a flattening of the Treasury curve, which buttress the optimistic outlook for long government bonds. Surging realized inflation has produced a recovery in market-based inflation expectations, which remain elevated and imply the curve should flatten. Further, our proprietary leading economic indicators are stronger relative to the one-year lookback, suggesting additional curve flattening. Solid equity returns have produced firm price momentum, which implies spread tightening for high yield bonds. However, given the limited room for further spread compression and a still superior long government bond forecast, we decided to further underweight high yield bonds in favor of long government bonds.
From a sector perspective, we maintain our targeted allocations to technology and communication services but split out our current consumer staples position with materials. Technology remains a preferred sector, scoring well across all factors except price momentum. Robust earnings and stellar balance sheets helped propel technology to the top of our rankings. Improving price momentum and earnings and sales expectations combined with strong macro scores served as the foundation for our beneficial communication services forecast. The outlook for consumer staples remain constructive, supported by strong revenue and positive valuations. However, price momentum has deteriorated and the sector now ranks similar to materials. Accelerating sales expectations combined with encouraging price momentum and helpful valuations moved materials up our rankings.
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The views expressed are of Investment Solutions Group as of 15 September 2021 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.
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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.
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Expiration Date: 30/09/2022