What does this mean for asset allocation within asset classes?
Solutions & Multi Asset
“Given the near-term uncertainty around global growth, we now have underweight positions in both credit and equities. We are particularly cautious on European equities and the euro, given the likelihood of recession in Europe. We have a more positive outlook for emerging market equities, including China, and Asia Pacific stocks excluding Japan, as well as select Emerging Market FX, given the diversification potential and possible support for commodity exporters. Finally, we are currently long USD – we expect interest rate differentials to support the dollar as the Fed remains focused on inflation, and for its defensive characteristics to provide protection should market conditions deteriorate in the shorter term.
Equities
“We believe focussing on high quality companies, rather than sector selection, is the best approach given the rising geopolitical and stagflationary risks. Companies with pricing power and the ability to protect margins should perform relatively strongly in this environment. Equities should still provide a robust source of income, now that balance sheets have been repaired following the worst of the pandemic. We are cautious on Europe given the risk of recession there, but see the potential to diversify in some emerging markets, particularly areas that are benefitting from the commodity price surge. Parts of China look cheap, though volatility is very high and tail risks have grown fatter.
Fixed income
“Stagflation presents a challenge, but there are some areas within fixed income that we think will be better protected from rising rates and slowing growth. Breakevens should continue to perform relatively well, on the premise that inflation expectations will rise, and we are also constructive on Euro Investment Grade (IG), given its more defensive characteristics and improved valuations. Fixed income investors should not fear duration. The upside for nominal yields will likely be capped by debt refinancing constraints, central bank actions and demand for safe havens. We think ECB rate hikes are unlikely in 2022 (despite the ECB sticking to its hawkish tone in March), and so see value in core European duration. We are more cautious on China. The property market remains a concern and we expect further volatility ahead.
Private credit
“The direct impact of the war on our portfolios has so far proven limited, with the markets’ resilience meaning there have been few dramatic pricing movements. Nevertheless, the wide-ranging and often indirect supply chain disruptions resulting from the war make this a period for careful active investing and credit selection. However, private credit can prove an effective hedge against inflation due to the floating rate coupons. It also offers a senior position in the capital structure and high levels of income with low volatility. Our focus now is on companies that can withstand broader cashflow and margin pressure.
Real estate
“The main risk to real estate right now is slower economic growth. We believe markets have been slow to react to the crisis, and as such we are exercising caution. Stagflation is also a concern. Real estate typically fares well through short periods of inflation, but less well in prolonged periods of stagflation. Nevertheless, we are still focused on long-term macro themes – healthcare, residential buildings and data centres – while inflation-linked leases offer a form of inflation protection.
“All in all, stagflation risks have intensified, with the war in Ukraine disrupting the global growth trajectory, particularly for Europe, and spillover effects tied to the path and timeline of a resolution. The conflict has also exacerbated inflation pressures, creating even more challenges for policymakers. We have been reducing risk since the start of 2022 and focusing on regions, sectors and asset classes that provide protection and income in a highly uncertain environment of slowing growth and rising inflation.”
