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.
Figure 1: Asset Class Views Summary
As we close the book on the first half of 2023, the US economy has outperformed expectations, but our view remains that growth will continue to slow and inflation pressures will ease. The sizable upward revision in Q1 GDP highlights the resiliency of the Unites States (US), but momentum should slow as lagged impact from higher rates and tighter financial conditions starts to tighten the bolts.
The recent CPI release was a welcome surprise to the downside, and we continue to believe disinflation trend remains intact. A meaningful decline in the Produce Price Index (PPI) and declines in prices paid for both the services and manufacturing indexes further support this view. While core inflation has remained sticky, we do not believe goods disinflation has fully run its course, particularly with goods consumption still running above pre-COVID levels. Used car prices have dropped, but still have further to go when evaluating the Manheim Used Vehicle Value Index, which remains exceptionally high. Services inflation should also ease on lower rents. Measures from Apartment List and Zillow signal a further decrease in owners’ equivalent rent from extreme highs, but a rise in unemployment is likely needed to bring this measure down to more historical readings.
Although risks have risen, recession is not a high conviction view for us. Consumers have been a pillar of strength, and to a large extent, they remain strong. Perhaps the continued spending is from improving confidence as the Conference Board’s Consumer Confidence Index steadily improved, hitting the highest level since January 2022. Labor market data has been mixed, and while the market is cooling, it remains strong. Similarly, wage growth continues to fall but remains elevated with the average hourly earnings sitting at 4.4%.
The level of consumer cash reserves remains highly uncertain and debated. The Fed anticipates excess savings to drain, but research by Citi estimates excess savings are still around 5.5% of GDP, down from around 10% in late 2021. Bank of America notes that liquid assets fell slightly this year but are still US$4.4 trillion higher than in 2019, suggesting an excess savings buffer.
Consumers are strong but are being increasingly constrained by the high cost of borrowing. Although demand is not collapsing, it is slowing. Most importantly, it will continue to slow in the months ahead even as disinflation offers a welcome support to real income. The recent FOMC statement cautioned that “tighter credit conditions for households and business are likely to weigh on economic activity, hiring and inflation.” Household debt as a percentage of disposable income in the US remains low, while corporations have low debt service ratios after both deleveraged following the Global Financial Crisis.
However, deterioration is bound to happen with the cost of credit rising for both businesses and consumers. Data from the Senior Loan Officer Opinion Survey reflects this reality with willingness to lend to consumers and large firms dropping to levels historically associated with recessions. The resumption of college loan payments will only work to further restrain consumers.
The labor market and wage growth, although gradually cooling, remain too tight for Fed. More easing in core services ex-housing is needed, which means wages need to cool more. Arguably, the Fed should be done with hiking, given the real borrowing costs, but given the above scenario, recent commentary and the latest summary of projections, a hike in July seems all but certain. For its part, market expectations have recalibrated higher and now better align with the Fed’s outlook.
On the surface, investor risk appetite has been resilient with our Market Regime Indicator (MRI) anchored in low-risk regime. However, under the surface, there is a disconnect between equity and bond markets, with our implied volatility in equity factor finishing in euphoria regime while our measure for risky debt spreads residing in normal regime. It is worth noting that both factors advanced higher over the final week of April.
Hotter-than-expected inflation prints, another bank failure and the fast-approaching debt ceiling deadline added more uncertainty. Implied volatility in currency also remained very benign with our measure residing in euphoria regime. Overall, the MRI still pointed to a favorable risk environment for equities, but we are cognizant of overhanging risks.
Our fundamentals-driven model remained constructive on global equities. Sentiment indicators, analysts’ expectations for both sales and earnings, improved, while top-down macroeconomic factors remained supportive. Lastly, our evaluation of valuation metrics, including free-cash-flow and buyback yields, remained slightly positive.
Commodities remained under pressure and our quantitative assessment forecast further pain as still unfavorable curve structures implied future prices may fall further.
Bonds benefited from the banking turmoil and expectations for a Fed pivot, but our model forecast higher rates. With nominal US GDP still exceeding the yield on long treasury bonds and headline inflation numbers receding quickly, our model suggested that yields might rise. Additionally, interest rate momentum also pointed to higher rates.
Overall, our quantitative forecast supported an overweight in equities, but we are mindful of the increased risks and decided to slightly reduce risk in our portfolios. We sold a small portion of our equity allocation and reduced our commodity exposure, going further underweight. Proceeds were deployed to cash, which boasted an attractive yield and could provide some insurance in the event investors become more fearful.
Within equities, we continued to reduce exposure to Pacific equities, now a healthy underweight. The offsetting buy was into emerging market equities, bringing our allocation to neutral. Our examination of Pacific equities pointed to weaker expected returns. Price momentum, both short and longer-term measures, was weak, while valuations became unattractive. Further, sentiment measures deteriorated as analysts revised expectations for both sales and earnings. Our expectations for emerging markets (EM) increased due to improvements across a few factors. Valuations remained attractive while better top-down macroeconomic indicators and healthier balance sheets supported EM equities.
Within fixed income, we sold intermediate government bonds, maintaining overweight, with proceeds invested in cash. As mentioned above, our model is forecasting higher yields and cash is more attractive on a relative basis.
At the sector level, we maintained our allocation to industrials, but rotated out of materials and consumer discretionary into energy and communication services. Industrials remained our top sector, exhibiting strength across all factors. Robust price momentum, strong sentiment and health balance sheet measures buoyed the sector. Our forecast for materials is positive due to decent price momentum and attractive valuations, but weak downgrades to both sales and earnings expectations drove the sector down our rankings. Consumer staples benefitted from sturdy price momentum and strong corporate balance sheets, but our evaluation of top-down macroeconomic factors and valuations dent the outlook and pushed the sector down our rankings.
The rapid increase in rates during 2022 weighed on the tech-heavy communications sector, but positive performance recently improved short-term price momentum, which supported the sector. Elsewhere, expectations for earnings improved and valuations remained attractive. Lower oil prices and recession fears weighed on commodities and sectors closely associated, such as energy. This is reflected in ongoing earnings and sales estimate downgrades and weaker short-term price momentum. However, longer-term measures of price momentum, still healthy balance sheets across energy companies and attractive valuation metrics strengthen the outlook for energy.
Click here for our latest quarterly MRI report .
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 through the period ended 11 July 2023 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.
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.
This document provides summary information regarding the Strategy. This document should be read in conjunction with the Strategy's Disclosure Document, which is available from SSGA. The Strategy Disclosure Document contains important information about the Strategy, including a description of a number of risks.
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.
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 reliable indicator of future performance.
Investing involves risk including the risk of loss of principal.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
This communication is directed at professional clients (this includes eligible counterparties as defined by the appropriate EU regulator) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication.
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.
©2023 State Street Corporation – All Rights Reserved
Expiration Date: 31/07/2024