Fading uncertainty improves outlook
While European equities have moved sideways recently, the US equity market is continuing its rally and has recently reached new all-time highs. However, in euro terms, Europe is still strongly outperforming the US year-to-date due to the weak dollar. Now that the uncertainty of tariffs has declined and we expect the world economy to keep growing, we are increasing our equity positioning from neutral to a modest overweight. Meanwhile, we add some cyclicality to our sector allocation by increasing our industrials positioning to overweight. Additionally, on the back of our changed rate forecast, we reduce the interest rate sensitivity (duration) of the bond portfolio back to neutral.
- Macro: increased clarity
- Equities: outlook improving
- Bonds: shifting duration stance
Macro: Increased clarity
The tariff shock continues to weigh on global growth with overall tariffs lower than in the aftermath of Liberation Day. However, the trade deals struck by the US in the summer have averted worst-case scenarios and provided clarity to companies and economies. As a result of the tariffs, we do expect growth of the world economy to slow, with Europe and the US growing below trend. However, the fading uncertainty and economic resilience make us increasingly confident that a recessionary scenario is unlikely.
Equities: Outlook improving
We are increasing our equity positioning from neutral to modest overweight as the outlook has improved and we see further upward potential. US equities have shown a strong rebound this summer after the April slump as tariff fears faded and clarity improved. Especially the big tech names of the magnificent seven have seen significant returns after a strong earnings season and continuing strength in AI expenditures. Additionally, the market is increasingly expecting the Federal Reserve (Fed) to start cutting rates, which can stimulate the market further. Although equity valuations are high, especially in the US, the market expects double digit earnings growth next year. Therefore, we believe that the strong equity momentum can continue. While increasing our equity positioning, we also upgrade our stance on the industrials sector from neutral to overweight, as the sector will benefit from defence spending. The industrials sector adds some cyclicality to our sector positioning. Though with our other preferences for the healthcare and financials sectors as well as negative views on the consumer staples and materials sectors, we retain an overall barbell positioning in our sector allocation. Our regional allocation remains unchanged with neutral views on the US, Europe and emerging markets.
Bonds: shifting duration stance
After multiple reductions earlier this year we cut our duration position back to neutral within the bond portfolio. The reasoning here is twofold. First, we think the rate cutting cycle of the European Central Bank (ECB) has ended for now, which is sooner than we anticipated. Additionally, ReArm Europe and the announced German infrastructure spending are fiscal stimulus measures that will be financed by new debt. This will be a tailwind for long-term yields and work against a long-duration position. This change in the portfolio duration does not affect our strategy though. We maintain a modest overweight for bonds and a preference for high-quality bonds over their riskier high-yield counterparts. Although we do not expect yields to drop, we do expect quality bonds to perform better than cash. We find higher yielding bonds unattractive as credit spreads are historically low and do not compensate investors for the additional risk.
Conclusion
As tariff uncertainty has faded and earnings expectations remain solid, we expect the equity momentum to continue. As a result, we increase our equity positioning to a modest overweight. At the same time, we add some cyclicality to our sector positioning by upgrading the industrials sector to overweight. In bond markets the end of the ECB rate cutting cycle and the European fiscal stimulus measures have made us reconsider the duration of the bond portfolio. Specifically, we have brought the duration back to neutral as we see potential for further upward pressure on longer term yields. Though we retain a modest overweight in bonds, with a preference for high-quality bonds.