The global economy appears to have entered a new phase — one of synchronized sustainability — but markets have been rising, and much of the good news is reflected in asset prices, particularly in the U.S. These conditions raise a number of questions heading into 2018: Where are we in the economic cycle? Is the U.S. priced for perfection? Have investors missed the rally in European equities? Will rising inflation impact asset prices? Here are key investment themes to consider and guidance on positioning portfolios for 2018:
Equity portfolios at Capital Group are constructed through individual security selection based on fundamental, bottom-up global research, rather than top-down tactical shifts. Through this bottom-up process, a number of themes have emerged. The table below shows shifts in regional equity weightings over the past six months across American Funds equity-focused portfolios. The shifts represent any allocations of 1% or greater during the period. Emerging markets exposure has been added across strategies, while European exposure has generally been increased and the reverse has been true with regard to U.S. exposure.
At this stage of the cycle, ensure portfolios are well diversified, with the flexibility to pivot to select areas of opportunity.
Maintain a core allocation to U.S. equities but consider rebalancing toward international and emerging market equities.
Seek meaningful exposure to Europe’s improving health and rising consumer purchasing power in emerging markets.
Capital Group’s fixed income team convenes a Portfolio Strategy Group (PSG) that meets regularly for an in-depth discussion on the macroeconomic environment and fixed income markets. The fixed income group's latest insights are reflected in the dials shown, which represent guidance to our portfolio managers when building our core fixed income portfolios.
Capital's Portfolio Strategy Group (PSG) continues to believe in a "lower for longer" thesis regarding the future level of interest rates. Modest global growth and inflation, as well as the attractiveness of U.S. interest rates in a global context, are a few factors contributing to this view. However, current consensus expectations for the path of short-term interest rates are more conservative than the PSG view.
Although the Fed is tightening monetary policy, the bias of central banks remains supportive of economic growth. In this environment, the fixed income group thinks the yield curve could steepen and long-term interest rates may rise somewhat more than intermediate rates.
In light of the fixed income group's view that inflation will continue to rise modestly, particularly in the U.S., the group suggests considering an allocation to Treasury Inflation-Protected Securities (TIPS). Further, TIPS valuations are attractive relative to prospective inflation.
High credit valuations suggest caution, given stable to declining fundamentals. Although the fixed income group does not expect a material rise in defaults for high-yield corporations, minimal allocations are appropriate to high-yield in core bond portfolios.
The fixed income group continues to recommend a less-than-index weighting in agency mortgage-backed securities on expectations of future spread widening as the Fed’s balance sheet reduction ramps up.
The asset allocations below are drawn from the 13 American Funds model portfolios, which are established by Capital Group’s Portfolio Oversight Committee. The committee, a team of experienced portfolio managers, makes strategic allocations to underlying American Funds based on stated investment objectives. The themes that follow are reflected in the asset allocations:
Maintain a core allocation of U.S. equities but market levels call for selectivity and rebalancing toward international and emerging markets equities.
Seek meaningful exposure to international and emerging markets equities for the potential to gain from Europe’s improving health and rising consumer purchasing power in emerging markets.
Seek to ensure core bond portfolios are positioned for rising volatility, with limited exposure to lower quality credit or high yield in order to provide relative stability and diversification.