We remain favourable towards risk assets, keeping the portfolio’s equity allocations close to historical highs. We continue to prefer developed over emerging markets.
We maintain a meaningful allocation to North America at 53 per cent. Despite the weakness mid-October, our positive outlook for the US economy continues, with above-trend growth expected over the near term.
The solid Q3 US earnings season implies strength at the corporate level, while the US employment situation continues to improve. The generally accommodative stance of the Federal Reserve is likely to lend further support. In our view, the US economy is moving from reliance on stimulus to a self-sustaining phase and, as the business cycle matures, monetary tightening will therefore be justified. With short-end rates likely to rise as the Fed starts to normalise policy but back-end rates compressed by loose policy outside the US, we anticipate continued flattening of the US yield curve. We also expect equity to return high single digits and credit to remain attractive as a carry trade.
While we expect a higher US dollar and anticipate a modest tightening of language as the Fed paves the way to higher short-end rates, we do not expect this to translate to meaningfully higher volatility in most asset classes.
Unquestionably global coordinated central bank action has had a significant impact in bolstering risk assets in the last few years. While policymakers remain committed to ensuring the economic recovery will progress, this will prove to be an increasingly interesting dynamic as policies and economies diverge.
Reliance on extraordinary monetary accommodation will decline as we progressively move towards a period of greater divergence, with rates moving away from zero in the US and UK, while policies remain accommodative in Europe and Japan.
Regional variations in the speed of normalisation clearly have implications for asset prices, with relative value decisions likely to assume greater significance. In our view, we are close to the point of transition when markets will begin to focus on a change of monetary regime.
Such a change in focus typically produces lower, more differentiated returns and it would be surprising if transition can be executed without triggering increased volatility. Having a multi-asset approach will be important.
Within fixed income, our view is that US interest rates may rise as the Fed continues to taper asset purchases. Therefore, we maintain a short position in five-year US treasury futures as a hedge against interest rate exposure gained via credit sectors, including high yield and emerging market debt.
Our positioning in high yield is lower than it has been historically. We remain relatively constructive on the sector because fundamentals are supportive and default rates remain low, but we are finding more attractive opportunities elsewhere. We anticipate rising rates in the US around the middle of 2015 and the portfolio is positioned to benefit from a gradual rise.
Talib Sheikh is manager of the JPM Multi-Asset Income fund