We are in a late cycle environment in which macro conditions are increasingly signaling deterioration, and this fact alone calls for nuanced portfolio construction. However, our macroeconomic analysis suggests that the economic softening so far has been largely offset by central banks around the world pivoting to easing, which has loosened financial conditions considerably. Looking forward, it still remains unclear if the loosening of financial conditions will manage to turn the outlook around.
Here is how we are positioning multi-asset allocation portfolios in light of our outlook for the global economy and markets.
Given broadly slowing growth, increasing geopolitical uncertainty, and generally higher levels of volatility, we are modestly underweight risk relative to our benchmark, and are building liquidity to take advantage of tactical buying opportunities.
We expect volatility and slowing profit growth to continue to restrain investor appetite for equities in 2019. Therefore, we have a modest underweight to equities with an emphasis on liquidity and high quality, defensive sectors. We favor large caps over small caps, U.S. equities over European equities, and have increased our weighting in high-dividend-yielding equities, which we believe should benefit from lower sovereign bond yields.
We prefer high quality duration as we move toward the later part of the cycle, as we still believe that fixed income offers an attractive diversifier for risk in portfolios, particularly given the dovish pivot of global central banks. However, we are selective in our exposures. Recognizing the significant moves lower recently, we still find U.S. rates the most attractive in developed markets.
Given our late cycle view, we expect corporate credit will underperform over the coming year. Within corporate credit, we prefer shorter-dated bonds from high quality issuers, especially in defensive and noncyclical sectors, which is in keeping with our quality and liquidity theme. The high yield underweight reflects in particular the glut of low quality leveraged loan issuance. We continue to favor non-agency mortgage-backed securities (MBS) as they remain a relatively stable alternative to corporate credit. We are also selectively receiving rates in select emerging market (EM) external credits where valuations look compelling, and that we believe will benefit from global developed market central banks pivoting to a more dovish rate path.
Historically, real assets tend to perform well in late cycle environments; however, that relationship has become less stable in recent periods. That said, we still view real assets as an effective tail risk hedge against rising inflation as well as a portfolio diversifier, and we therefore maintain a modest allocation to what we feel are attractively valued opportunities, including U.S. Treasury Inflation-Protected Securities (TIPS).
We have a nuanced view on currencies, and expect more significant alpha opportunities to emerge outside of the major currencies. The dovish pivot by developed market central banks argues for an overweight to those EM currencies that are both attractively valued and higher yielding. We have paired this risk with an underweight to export-heavy Asian currencies that are closely linked to China.
For detailed insights into our views across asset classes, our systematic framework for tactical asset allocation, our macro momentum model that helps inform portfolio positioning in changing macro crosscurrents, and our approach to equities, please read our 2019 Asset Allocation Midyear Update.
Erin Browne is a managing director and portfolio manager in the Newport Beach office, focused on multi-asset strategies. Geraldine Sundstrom is a managing director and portfolio manager in the London office, focusing on asset allocation strategies. Mihir Worah is PIMCO’s CIO Asset Allocation and Real Return.