Mega-cap tech strength continues to fuel gains

Welcome to the July edition of Inview: Monthly Global House View. In this publication we consider significant developments in the world’s markets, and discuss our key convictions and themes for the coming months.

The stock market rally continued in June. The MSCI World Index increased by 2.0% over the month, bringing its year-to-date gains to 11.8%. US stocks have outperformed other developed markets driven by the continued strength of mega-cap technology companies which account for more than one third of the S&P 500 index returns for the year-to-date. Weaker macroeconomic data in the US has fueled expectations of interest rate cuts at the Federal Reserve meeting in September, contributing to a modest decline in US bond yields over the month.

In Europe, the outcome of the European Parliament elections resulted in French President Macron calling a Legislative election, prompting a widening of French government bond spreads. However, yields in other European government bonds have remained stable indicating limited contagion to the rest of the region.

Corporate earnings growth continued to trend higher, supporting stock markets over the month. Companies in the technology, communication and consumer discretionary sectors saw the largest upward revisions to expected earnings during the month. This supported an improvement in investor sentiment towards riskier assets, particularly in the US and parts of Asia. Although headlines have been focused on technology firms, profit margins have also recovered in other sectors as a deceleration in US inflation reduced input price pressures.

Despite better-than-expected GDP data in the first quarter of the year, signs of deceleration in the US economy are starting to appear, for example declining economic surprise indices and weaker business sentiment. Furthermore, the US yield curve remains inverted, something that is often associated with a weaker macro environment. We maintain that a moderate overweight to equities continues to be advisable for balanced portfolios. However, we have reduced our exposure to US equities, given our relative preference for Europe, UK and Asia. In fixed income, we have increased our allocation to sovereign and high-quality corporate bonds to help manage portfolio risks.

Asset Allocation

Global Allocation

Following strong performance in May and June, equity exposure is being reduced to take profits. The overall equity allocation remains slightly overweight, not yet ready to turn neutral given that seasonality in July is historically good while earnings trends remain positive. The reduction in equities will fund an increase to fixed income exposure, taking it to an overweight position. This is supported by further interest rate cuts being expected in Europe alongside evidence of a slowdown in US economic activity. The record short positioning in US Treasuries by investors, together with weaker data on consumer spending and credit card delinquencies, support the argument that interest rates are coming down soon. The focus should be on high quality bonds. No changes were made to our alternatives and cash positions, both of which remain underweight.

Fixed Income

Within fixed income we maintain the focus on sovereign risk without taking additional credit risk due to increased signs of a slowdown in the US economy. While there is a possibility that yields may overshoot to the downside, we believe that large fiscal deficits will put a floor under yields so this does not warrant any changes to exposure. Emerging market debt technicals have come down slightly to a neutral view although this is not enough to prompt a change in stance just yet. The benchmark duration has increased and so we are raising portfolio duration up to 5 years to be one year above the benchmark for USD portfolios.

Equities

Our Asia ex-Japan exposure is being increased, adding to our overweight, given a positive spillover effect from edge artificial intelligence as well as attractive valuations. There is also continued confidence in China’s recovery, albeit slowly. Within Asia, Taiwan and South Korea are being added to, in particular technology names that are relatively cheap. India is being taken back up to a neutral allocation following the election. To balance out this increase, US positioning was reduced to be further underweight as valuations are looking relatively stretched. Our UK equity overweight is maintained, as we believe the environment remains supportive given positive momentum from the election and the expected rate cuts from the Bank of England, potentially in August. Once the election is over and rates start to come down, there is a chance we will look to reduce risk. European exposure is also held at an overweight despite recent political uncertainty.

Alternatives

Within our alternatives exposure we maintain our underweight to commodities versus the benchmark, with the majority of our commodity exposure coming from gold which was roughly flat in June. Industrial metals and agricultural commodity prices underperformed during the month, suggesting weakness of the global economy. No changes were made to our overall hedge fund weighting, holding a neutral allocation, although we note that Trend Commodity Trading Advisor (CTA) performance has been soft over the last two months so we are now looking to re-allocate having pared back exposures over the last 3-4 months.

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