Macro Matters: World Economies Bouncing Back

Updates to our economic outlook:

Geopolitical risk has subsided in recent weeks, reducing the inflation tail in our view. Demand reallocation in China helped keep oil prices at a lower ceiling, and this has passed into the macro data. Global growth surprises continue to improve as expectations pick up. That said, the shift is disparate by region. The artificial intelligence (AI)-led investment boom coupled with resilient consumer spending (and easier financial conditions) sees U.S. growth remaining resilient, despite a sequential decline in the Atlanta Federal Reserve (Fed) GDPNow forecast. Parts of Asia see a tailwind from the same theme, with a potentially stronger wealth effect that could keep consumption robust. The EU is one of the key areas of growth disappointment, with no growth engine and a pullback in fiscal stimulus (as we have expected). China continues to feel pressure from subdued consumption but sees a tailwind from industrial investment and exports. The worst of the property drag is likely past.

From an inflation perspective, sequencing is important. Near-term inflation data is likely to show significant weakness because of the energy price decreases; however, in the U.S., we have seen signs of widening and more entrenched inflation. This does not come as a surprise to us, because in a capital- and fungible commodity-heavy investment boom, it is natural for firms to retain some pricing power, and we think that coupled with competition is a strong tailwind for medium-term U.S. growth. The EU is breathing a sigh of short-term relief on pricing, until it must begin filling its gas tanks again, and in China, it’s a balance with deflation and a property bubble that is not yet resolved.

Market pricing has become slightly more hawkish in the U.S., but we believe the Fed will remain on hold until such time that inflation looks to be getting out of control (not our base case). If Personal Consumption Expenditures can sequentially come below 3.5%, we believe this will behave like a line in the sand. The rest of the developed markets (DM) need a cutting cycle, just as many EM are likely to be forced into hiking rates.

Our base case remains a Fed that is on hold and data-dependent, European rate pricing that is likely too hawkish for the moment, and DM-ex-U.S. growth that remains a problem. We continue to see green shoots for EM-ex-China.

Prospective changes to asset allocation:

• Equities
We continue to favor a barbell of equities, which reflects our approach of being sentiment aware and blending in fundamentals. We remain strongly positive on exposure to broad Asian markets via the Nikkei Stock Average (Nikkei 225) and EM, balanced with the newer overweight exposure to the eurozone. We retain an underweight view on Australian and Chinese equities. We believe eurozone equities have the potential to catch up as the peak of geopolitical stress is likely behind us and with rates expected to lower. One disadvantage of the eurozone is a relative lack of AI exposure. From a portfolio construction perspective, we think this lack of AI exposure is a strong positive as the market contends with a flood of equity issuance and IPOs related to this theme and begins to question the return on investment.

• Fixed income
We remain neutral on U.S. duration, with a preference for the medium part of the curve while underweighting the long end of the curve. Rates in DM-ex-U.S. markets remain elevated and volatile, and we see longer-term attractive entry levels given attractive all-in yields.

• Commodities and foreign exchange
We continue to favor commodities with a broader focus. We shifted our directional energy exposures to relative value over the last 8 to 10 weeks, as geopolitical risk became increasingly noisy. We continue to favor industrial metals on the AI buildout and agricultural commodities, as we see fundamentals deteriorating. From a currency perspective, we remain positive on selected countries benefiting from a growth trajectory, orthodox monetary policy, and strong starting rates.

Multi-asset allocation views:

These multi-asset views reflect tilts to our strategic asset allocation models and are based on a 6- to 12-month time horizon, driven by both quantitative and fundamental research.
+ (Overweight on overall asset class)    
= (Neutral on overall asset class)  
– (Underweight on overall asset class)

Forward investment implications:

The Atlanta Fed GDP tracker (formally called GDPNow) is a real-time estimate of U.S. economic growth produced by the Federal Reserve Bank of Atlanta. It is a model-based, continuously updated forecast of real U.S. GDP growth for the current quarter, expressed at an annualized rate.

Carry refers to the net return earned from holding an asset over time, independent of price movements, after accounting for the costs of financing or maintaining that position.

Curve steepener refers to a change in the yield curve where the difference between long-term interest rates and short-term interest rates increases, making the yield curve steeper.

Duration is a measurement of the sensitivity of a bond’s price to changes in Treasury yields. A fund’s duration is the weighted average of duration of the bonds in the portfolio. Duration should be interpreted as the approximate change in a bond’s (or fund’s) price for a 100-basis-point change in Treasury yields. Duration is based on historical performance and does not represent future results.

Hedging a bond means using a separate investment to offset the potential risks of the bond.

The Nikkei Stock Average (Nikkei 225) is comprised of 225 stocks selected from domestic common stocks in the 1st section of the Tokyo Stock Exchange, and is a leading benchmark for Japanese equities.

Personal Consumption Expenditures (PCE) Price Index
The Personal Consumption Expenditures (PCE) Price Index reflects changes in the prices of goods and services purchased by consumers in the U.S. It is part of the Personal Income and Outlays Report issued by the Bureau of Economic Analysis of the U.S. Department of Commerce. You cannot invest directly in an index.

Purchasing Manager Index (PMI) is an economic indicator that measures the health of a country’s manufacturing or services sector.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

This material is provided for informational purposes only and is intended for retail public distribution in the United States. Use outside the United States is for professional/qualified investors only.

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