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Schroders CIO Lens Q1 2024: Asset allocation views

16 February 2024 Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment at Schroders
Johanna Kyrklund

Johanna Kyrklund

In the latest quarterly Schroders CIO Lens Q1 2024, Schroders shares its view on various global asset classes.

Equities
We held a positive view on equities for most of the quarter as lower bond volatility and an absence of recessionary risks remained supportive of the asset class. Most recently, our expectations of a peak in US interest rates and a soft landing were corroborated by Federal Reserve chairman Jerome Powell. However, strong returns across equity and bond markets mean our soft-landing view has now been priced in, and so we move to neutral.

US:
Despite holding a positive view at the start of the quarter, we have moved to neutral as the market has now priced in our expectations that US interest rates have peaked and that there will be a soft landing. Within the market we prefer the equal-weighted S&P 500 index as we expect a broadening out of performance away from the “Magnificent Seven”.

UK:
We are maintaining our neutral view on UK equities where, despite a slight reversal in the dire economic outlook, the Bank of England must move cautiously to mitigate the risk of stagflation.

Europe (ex UK)
We were negative on Europe at the start of the quarter predicated on high inflation and the decline in manufacturing. We have since moved to neutral as the economic data has started to surprise to the upside, and as cheap valuations resulting from excessive pessimism mean we believe Europe is less likely to underperform other markets.

Emerging Markets
Given that the manufacturing recovery will impact emerging markets unevenly, we retain our neutral view.

China:
We are maintaining our neutral view on China as the elimination of speculative demand for housing continues to weigh on the economy. We do, however, see early signs of life in the export cycle and are mindful of the possibility of more stimulus measures.

Asia ex. Japan
We have kept our neutral view as overall signs of life in the global manufacturing cycle are modest. However, we favour Korea and Taiwan relative to other markets as they should be supported by positive demand for semiconductors.

Japan
We downgraded our outlook on Japanese equities to neutral at the end of the quarter. While we still like Japan for its structural growth story, we believe that the Bank of Japan could push ahead with normalising monetary policy, which would likely put upward pressure on the yen.

Government bonds
Following an upgrade mid-quarter, we have moved back to neutral as bonds have rallied alongside risk assets, with the market now pricing in significant rate cuts. We think that for yields to fall further, we need to see evidence of an increased risk of a hard landing.

Credit
We have turned neutral on credit following the significant tightening of credit spreads towards the end of the quarter. Valuations in US investment grade bonds now reflect an optimistic outlook for 2024 and have become more expensive. Default rates have started to increase in both US and European high yield without reflecting significant credit stress. However, fundamentals have started to turn and may deteriorate going forwards.

Commodities
We have owned commodities as a hedge against stagflation and geopolitical risks. However, we downgraded our view to neutral in December given a lack of discipline on quotas among oil producers, and minimal signs that demand across the spectrum will pick up and support higher prices in the new year.

We downgraded energy to neutral at the end of the quarter. Despite OPEC members recently agreeing on further cuts, many are failing to comply with pre-existing quotas, undermining the threat of a squeeze on supplies. Meanwhile, US oil productivity continues to improve, further reducing the risk of prices rising.

We have downgraded gold to neutral as despite buoyant central bank and Chinese domestic demand, the recent rally has left the price looking overbought.

We remain neutral on agriculture as despite poor weather putting upwards pressure on wheat prices, the general outlook remains balanced. Similarly, we remain neutral on industrial metals. Although the supply-side remains tight, there is currently no indication of an increase in demand.

Fixed income views

Government
With our cyclical model firmly in slowdown mode, we upgraded duration in November. At the time, the steepening of the yield curve also made owning the US 10-year less punitive. As our expectations of a peak in US interest rates and a soft landing were later corroborated by comments from Jerome Powell, we moved back to neutral. Strong returns across bond markets mean that our soft landing view is now priced in, making it difficult for us to keep a positive view. Looking to regions outside the US, we have remained neutral throughout the quarter. Despite cooling inflation in the UK, concerns surrounding persistently strong wage growth and supply-side issues keep us neutral. In Germany, markets look to have priced rate cuts too aggressively at the short end of the curve, whilst more medium-term tenures should be supported by inflation undershooting on the downside. This mixed picture keeps us on the side-lines.

Inflation-linked
We remain neutral. Although there is a risk of inflation returning, we believe the Fed’s hiking cycle has brought inflation under control in the short to medium term.

EMD
- Denominated in USD: Although the light supply of bonds remains favourable, continued expensive valuations have kept us neutral overall.
- Denominated in local currency: Although the light supply of bonds remains favourable, continued expensive valuations have kept us neutral overall.
- High yield (HY): We upgraded our outlook on US high yield debt at the start of the quarter as absolute yield levels became very attractive. Corporate and household balance sheets also remain relatively strong, leaving them in good stead to digest tightening financial conditions and any moderation in growth. We retained our neutral score on European high yield debt as default rates have started to rise steadily albeit from a low base.
- Investment grade (IG) corporate: We are neutral on both US and European investment grade debt. Credit spreads tightened towards the end of the quarter amid growing speculation that interest rates have peaked. This narrative provided a powerful technical tailwind leaving investment grade valuations constrained by cash once again.

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