Macro update

We believe the global economy continues to improve and we expect its upward trajectory to persist for the rest of the year. Based on our macro regime framework, the global business cycle remains solidly in a recovery regime, with growth below trend and expected to improve over the next few months. The recovery is strengthening in its depth and breadth, as our leading economic indicators suggest growth is broadening across regions. While global equity and credit markets experienced declines over the past month, our measures of global risk appetite remain in an improving trend, indicative of improving growth expectations (Figure 1).

Figure 1: Leading economic indicators and market sentiment suggest the global economic recovery continues across all regions.

Investment Positioning

We have not implemented any change in our portfolio over the past month (Figure 2). We maintain a higher risk posture than the benchmark¹ in our Global Tactical Asset Allocation model, sourced through an overweight exposure to equities and credit at the expense of government bonds. In particular:  

• Within equities we hold large tilts in favor of developed markets outside the US and emerging markets, driven by more favorable cyclical conditions, attractive local asset valuations and an expensive US dollar. The confluence of these medium and short-term drivers increases the potential for long-term capital inflows in non-US equity markets. As a result, we hold a large underweight position in US equities, especially in quality and momentum stocks, given our tilts in favor of value and (small) size factors, which we believe should eventually benefit from higher operating leverage and a recovery in the global earnings cycle.
• In fixed income we maintain an overweight exposure to US high yield credit, emerging markets sovereign dollar debt, and event-linked bonds at the expense of investment grade corporate credit and government bonds, particularly in developed markets outside the US. Overall, we are overweight credit risk and neutral duration2 versus the benchmark.
• In currency markets we maintain an overweight exposure to foreign currencies, positioning for long-term US dollar depreciation. Within developed markets we favor the Euro, the Canadian dollar and the Norwegian kroner. In emerging markets, we favor the Indian rupee, Indonesian rupiah and Russian ruble.

Figure 2: Tactical Asset Positioning

US election scenarios and investment implications

Our investment process does not explicitly consider, or position for, the outcome of the US election. As discussed in more detail below, we believe the overall performance of risk assets is likely to be positive over the medium term (multiple months or quarters) regardless of the election outcome, and it can be driven by more enduring drivers of market performance such as growth, fiscal and monetary policy. However, the outcome of the election could have lasting consequences in terms of relative sector and regional performance for equity markets, depending on future changes in fiscal and trade policy over the coming years. While it is important to outline the potential impact of these alternative developments, we do not position for either outcome ahead of the election and follow our macro-driven investment process.

From a risk analysis standpoint, we evaluate three election scenarios, sorted from most positive to least positive in terms of expected impact on our portfolio. Before discussing the potential outcomes, however, it’s important to discount the near-term uncertainty that will likely characterize the days and weeks after Election Day. Given the high number of absentee ballots expected to be cast this year, processing times are likely to be slower than in previous elections, and it may take several weeks to process the vote count, in our view. States certification deadlines generally range between 1-2 weeks post-election day. Furthermore, given the pandemic, some states may ask for an extension. Therefore, regardless of whether election results will be contested, markets will likely need to digest some uncertainty for a few weeks after election day. We believe these developments to yield a neutral impact on our model portfolio. Rising risk aversion may provide a headwind to our equity, credit and foreign currency overweight. On the other hand, our relative value tilts in equities may benefit from a rise in the US political risk premium, given an underweight to US equities and overweight to global ex-US markets. Similarly, an unwind of extended positioning in momentum/growth sectors may potentially benefit our positioning in value sectors.

Biden Win + Democratic Congress

Among all scenarios, we believe a Democratic win of the White House and Congress would deliver the potential for meaningful policy changes. Overall, we think the impact on equity and credit markets is likely to be positive in the medium-term, despite risks of an initial sell-off. Given the fragility of the post-COVID job and growth environment, we believe the Biden proposal for higher corporate and personal income taxes is likely to be delayed and/or dampened. In addition, projected increases in infrastructure spending should support growth in the near term and provide an offset to negative impact from higher taxation3. Reduced trade policy uncertainty may also benefit risk assets, as, in fact, trade policy was the largest headwind to global growth in 2019. We expect this scenario may have a positive impact on our model portfolio, with emerging and developed markets outside the US being the main beneficiaries of lower trade uncertainty, and the US dollar likely to depreciate in tandem. Changes in fiscal policy may provide a catalyst for the long-awaited cyclical rotation from growth/momentum sectors into value sectors, with materials and industrials to potentially benefit from large infrastructure spending, and consumer discretionary to potentially benefit from higher minimum wage proposals.

Biden Win + Split Congress

In this scenario, we believe equity markets outside the US, particularly emerging markets can benefit from lower trade policy uncertainty and a more diplomatic engagement by the White House on trade disputes with other countries. However, a split Congress should translate into largely unchanged fiscal policy on matters such as healthcare, infrastructure spending, minimum wage and tax reform. Historically, policy impasse has often translated into a “no news is good news” narrative, which tended to favor risk assets and dampened markets volatility. However, this scenario would probably preserve the status quo in terms of relative sector performance, potentially minimizing one catalyst for the growth-to-value rotation. We believe this scenario may have a moderately positive impact on our model portfolio.

Status quo: Trump Win + Split Congress

A continuation of the status quo should be received well by risk assets, lead to US dollar strength in the near term, and reinforce the trend of US equity outperformance, especially for growth and momentum stocks, in our view. A continuation of the current trade policy framework is likely to be a headwind for emerging and developed market equities outside the US, on a relative basis. This scenario would likely deliver a negative impact on our model portfolio, given our overweight exposures to value, size, foreign exchange and equity markets outside the US.

Footnotes:

1. Source: Global 60/40 benchmark (60% MSCI ACWI / 40% Bloomberg Barclays Global Aggregate USD Hedged).

2. Source: Credit risk defined as DTS (duration times spread).

3. Source: The Congressional Budget Office estimates that a Democratic Platform could lead to an additional $2trl in deficits over the next decade relative to the current baseline.

Important Information

Blog Header Image: Denys Nevozhai / Unsplash

The Barclays Global Aggregate Index is an unmanaged index considered representative of the global investment grade, fixed income markets.

The MSCI All Country World Index is an unmanaged index considered representative of large- and mid-cap stocks across developed and emerging markets.

Credit risk defined as DTS (duration times spread).

Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their financial professionals for a prospectus/summary prospectus or visit invesco.com.

The opinions expressed are those of Alessio de Longis as of September 9, 2020, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions, there can be no assurance that actual results will not differ materially from expectations. Diversification does not guarantee a profit or eliminate the risk of loss.