Monthly Asset Allocation Outlook

We maintain our overweight view on US equities. We continue to believe that a broadening of earnings growth outside of large-cap tech supports the outlook and do not think a rotation will derail the positive backdrop. Second-quarter earnings were generally positive and signal that this regime shift can be sustained. The S&P 500 Index appears expensive when evaluated using traditional valuation metrics. However, when adjusted for declining interest rates and long-term earnings growth potential driven by AI, the US index appears closer to fair value.

We continue to have an underweight view on European equities. Earnings of European companies are expected to be somewhat lacklustre in the coming 12 months. While the consumer remains broadly upbeat and growth is recovering from low levels, the economy remains relatively less robust than other regions. Relative valuations remain attractive in Europe, but we do not see a compelling near-term catalyst for equity outperformance. 

We have upgraded our view on Japanese equities to overweight. Japan was at the centre of recent equity market volatility and has still not returned to its previous peak. We believe much of the volatility was driven by technical dynamics rather than fundamental weakness, and therefore think this is an opportunity to lean into the market. We believe the structural case for Japanese equities, including an improving macro backdrop and corporate reforms, remains largely intact.

We retain our underweight view on emerging market (EM) equities. This view is largely driven by a deteriorating outlook on Chinese equities. Cyclical and structural headwinds persist for Chinese assets and we expect trade tensions with the US to weigh on the outlook into the US elections in November. In addition, continued weakness in Chinese property market data acts as a further headwind to any broader economic recovery.

Within our overall duration overweight view, our relative preference for US rates remains neutral. The Treasury market now prices rate cuts in each US Federal Reserve (Fed) meeting this year, starting in September, which we view as fair value. We expect the Fed to take a gradual approach from there as inflation and labour market data evolve, given that the likelihood of a recession remains low.

We still have a neutral view on European government bonds within our core duration allocation. We believe disinflation across the European Union has further to go and we see less risk associated with fiscal policy and term premia; however, we view current pricing as reflective of the likely policy path from here.

We maintain a neutral view, given our expectation that the Bank of Japan (BOJ) will remain patient as it looks to normalise policy. Following recent volatility, we continue to watch the narrative from the BOJ for signals of what happens next. We are seeing top-line Japanese growth remaining weak and inflation slowing. Nevertheless, we still agree with the narrative that, over time, Japan will phase out extraordinary monetary easing.

We anticipate that spreads will likely remain rangebound, with little room for further tightening. As a result, we see little potential for capital gains; hence, our neutral view in favour of high yield.

We maintain an overweight view on high yield relative to investment-grade credit. We expect high-yield debt to benefit from better overall conditions for risky assets. While spreads remain tight, total income provides a substantial cushion against spread widening in the absence of a significant rise in default rates, which is not our base case.

We have upgraded our view on EM debt to neutral. While we still expect low growth in EM economies, we now see a lower return differential between credit assets. We expect the Fed cutting cycle to provide a tailwind for the asset class and, with many of the idiosyncratic stories having played out, we believe the asset class is at fair value. Flows into the asset class remain weak, which we believe will continue to be a relative headwind.

We continue to hold a neutral view on energy markets. Prices have been falling recently as markets appear to take heightened geopolitical risk in their stride, but we still believe oil is close to fair value, especially as worries about global demand have increased on the margin. We await better entry levels before re-entering an overweight position.

We maintain a neutral outlook on gold markets. Gold has meaningfully outperformed real rates over the recent inflationary period, which, in our view, limits further price upside from here. A punitive roll yield requires a substantive price appreciation to justify any overweight.