Asset allocation views: a variable growth outlook
Investors face an uncertain economic growth outlook but should still find opportunities in equities and fixed income as global central bank easing takes hold. We review some of the themes informing our latest asset allocation outlook.
The U.S. Federal Reserve’s (Fed’s) decision to cut rates by an aggressive 50 basis points in September not only brought the world’s most powerful central bank in line with what is now a global easing cycle, it also cemented the notion that the Fed has shifted from its sole focus on inflation to also supporting full employment. With growing signs that the job market is now cooling, as well as considerable uncertainty about growth going forward, this shift in focus suggests the Fed could reduce rates more aggressively than what the central bank has so far telegraphed. We expect the Fed funds rate to close the year at 4.25% and to reach a neutral level of 3.00% by the end of 2025.
A soft landing?
With U.S. growth slowing across many sectors, the big question is whether the U.S. economy will achieve the hoped-for soft landing or whether there will be a more pronounced disruption or perhaps a recession. That is still very much up in the air, though we expect the U.S. economy to muddle through and either experience a mild recession or none at all. But with pain points emerging in business development and consumer spending, and with disappointing macroeconomic data sure to come, there is likely to be some turbulence for financial markets (to stick with the metaphor) on the way down.
Beyond the United States, there have also been periods of weakness in large parts of Europe, Japan, China, and of course, Canada, and it’s likely there will be inconsistent or weaker global growth moving forward. With equities having performed well and credit spreads narrow, that leaves little leeway if the economy starts to weaken. Given that, we see logic in building some additional ballast into portfolios. On a broad asset class level, we’re neutral on both equities and fixed income as both the growth outlook and current geopolitical uncertainty could be headwinds for riskier assets as we move through the fourth quarter.
That said, we still see opportunities in the current market with the potential to capture upside. We’re still overweight U.S. equities, as we feel the large-cap growth story still has some legs, but we hold our position with a bit less conviction than last quarter, given the run-up in U.S. valuations.
U.S. equity performance
In Canadian equities, we’ve shifted to a neutral position from underweight, as we see the Bank of Canada’s dovish policy stance as a potential catalyst for a market with relatively attractive valuations compared to other developed economies. We also see potential in U.S. small-cap equities and so are maintaining our overweight in that sector, as well as in Asia-Pacific excluding Japan, and in the infrastructure sector.
In fixed income, our overall neutral position includes an overweight stance in emerging-market (EM) debt as we see the potential for EM currencies to appreciate versus the U.S. dollar as the Fed reduces policy rates. Conversely, we’re underweight U.S. high-yield debt and would favour leveraged loans instead due to their floating-rate nature and their comparably attractive spreads. While we’re maintaining our neutral position on U.S. investment-grade credit, we do value quality in the current spread environment and would gravitate toward it at the expense of lower grades.
Private markets mixed
The outlook for private markets continues to be mixed, with signs of recovery in Europe and Canada, but with transactions in the United States challenged by high financing costs and tight credit conditions. However, over the long term we see generally higher returns for many private asset classes versus public markets given current public market valuations and the potential for strong private market demand. We are overweight private credit and global infrastructure but hold an underweight view on private equity and U.S. real estate.
As we head through the fourth quarter, a positive development we expect to continue is a broadening of participation across geographies—the impact of additional stimulus in China—and asset classes, such as the fading dominance of large-cap tech equities. We expect to embrace this notion of balance in our portfolios, where we aim to continue to participate in upside while shoring up our defensive ballast.
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