The strong performance in July reflects a macroeconomic environment in which activity has remained stronger than expected and recession fears have abated. The IMF’s World Economic Outlook update pointed to near-term resilience as it upgraded its GDP growth forecasts for 2023. Furthermore, headline inflation has rolled over, reflecting the mechanical impact of base effects due to high inflation in 2022, as well as declines in energy prices. However, core inflation has remained more persistent.
Markets have also taken note of favourable developments on the policy side. Despite core inflation’s persistence, central banks appear to be close to the end of monetary policy tightening cycles. In addition, China’s Politburo meeting concluded with recognition of the need to support domestic demand, though no specific measures were announced to do so.
The implications for the asset allocation of a diversified portfolio are that, in our view, maintaining moderate overweights in both equities and fixed income assets remains justified. Within equities, a preference remains for emerging markets and, in particular, Asia and Latin America. Japanese equities are also favoured and an underweight allocation to the US is retained to offset the overweights.
Within fixed income assets, longer-dated government bond yields continue to be attractive given monetary policy cycles are drawing to a conclusion and the diversification benefits. With the potential for the lagged impact of interest rate increases to cause a deterioration in the macroeconomic environment, a preference for high quality fixed income assets continues to be appropriate. This means that overweight allocations to investment grade and sovereign bonds remain funded by an underweight allocation to high yield bonds.
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