Asset allocation and Sector Focus in Summer 2024

As part of our focus on providing a high quality, personalised investment service, we look to support our investment managers in their decision making when it comes to constructing client portfolios.

Our asset allocation committee is one example of this, via their monthly output showcasing their views on a global basis; this is then complemented by a sectoral view from the stock selection committee. The combination of these top down and bottom up opinions is an important resource for our investment managers to validate their own investment theses or to generate new investment ideas.

These committees, which consist of members of our research team and a number of investment managers, aim to provide a view that seems most suitable in the current climate. The output of the monthly meetings remains a suggested stance and it is important to note, that the views expressed are those of the committees and may not necessarily be those of your individual investment manager.

Here we present a snapshot of the current views.

SECTOR FOCUS

Overweight

Neutral

Underweight

Communications		The telecoms sector has benefitted from above-inflation price rises as many contracts are structured with Consumer Price Index + % increases, yet this will abate now as global inflation rates are falling. Rising debt costs remain a headwind (albeit a reducing headwind) as companies are forced to refinance at higher levels. The portions of the sector more exposed to consumer discretionary spending would struggle in a recessionary environment, although streaming companies may be more resilient.
Consumer Discretionary		Inflation has been falling, but the performance of the sector is likely to continue to be driven by macro considerations, as the sector remains pinned to the economic cycle. The non-essential element of their products/services makes them less resilient to a downswing. From the pandemic, businesses have been supported by excess consumer savings. With savings depleted, the risk of higher rates for longer looms over the sector and underpins our underweight stance.
Consumer Staples		Input costs have been a headwind for the sector, however, given abating inflation this should start to reduce. Non-discretionary demand provides defensiveness. Pricing power has been resilient, while volumes are flat to negative. As consumers are more wary of budgets, growth will likely be suppressed as firms will be not able to rely on price as much, turning to a more balanced relationship between price and volume. 2025 could provide a rebound in growth and it would remain wise to focus on the longer term.
Energy		Last quarter saw the oil majors moving in line with oil prices, except that when oil fell back down in price, the oil majors did not come off as well as expected. Brent started the quarter at $81 and ended at $83. In mid-April it peaked at $92. Sadly for the UK oil majors, they suffered more than the US majors (Chevron and Exxon) on the way down. We are neutral on energy at these levels because we are close to an oil price which drives demand destruction.
Financials - Banks		In the past quarter, UK banks outperformed their US counterparts. The prospects for US banks are muted by expectations that the US economy is about to cool off and that rates will fall. Lower interest rates put pressure on banks' net interest margins, which is the difference between the rate that they lend at and what they pay depositors. Rate declines for UK banks are expected to be lower than in the US. With buoyant non-life insurance rates and the prospect of a soft landing, we moved to neutral on this sector.
Health Care		Biopharma has performed better recently as the sector has proved resilient, in addition to the ongoing tailwind being provided by obesity drug makers. Med tech performance has been more mixed but medical procedures growth remains resilient as the sector continues to recover from the effects of Covid. Valuations have increased recently but we still see long-term value in the sector. Longer-term demand remains resilient and the structural drivers associated with an ageing population are unchanged.
Industrials		Industrial indicators started to showed signs of recovery in the first quarter of 2024. The results of industrial equities were generally as expected. While areas of demand weakness and destocking make conditions challenging, there are signs of improvement as we head into the second half of 2024. With interest rate cuts being anticipated and better than expected UK and Eurozone GDP growth, the soft-landing scenario looks increasingly likely. This should support earnings growth later in 2024 and so we remain patiently overweight.
Information Technology		Performance in the sector continues to be driven by generative AI. Valuations look rich compared to historical multiples, and the sector is increasingly driven by a handful of very large companies. The sector is interest rate sensitive and so we would expect any rate cuts to be a tailwind, albeit less so following recent outperformance. The lack of margin for error provided by valuations and the increasing capital intensity of AI players drives our rating, yet we remain attracted to the sector longer term.
Materials		China is still the largest medium-term influence, although the press would have us believe that speculators are the strongest influence in the very short term. China appears to be heading towards its official government 5% GDP growth target and so additional stimulus is not required. We don't think that China will be supporting prices going forward. Longer term, the dynamics of the copper market and a possible bull move in the commodity super cycle remain supportive.
Real Estate		High rates saw volumes of commercial real estate transactions plummet in 2023, as valuations fell with heightened borrowing costs. Imminent rate reductions should help stimulate activity, helping investors to reduce their ‘risk off’ position. The market is at risk of inflation reacceleration and delayed rate cuts, but on balance we believe an uptick in the real estate sector is due on the back of easy comparatives and an improving economic landscape.
Utilities		The quarter saw Thames Water's financial condition deteriorate, with its parent Kemble Water Finance defaulting on a bond payment. The situation highlights the challenges faced by water companies as the next regulatory cycle 'AMP 8' approaches in April 2025. A key component of the UK’s energy transition will be reform of energy infrastructure, which should be supportive of asset base and earnings growth for UK power names. For this reason, we prefer power utilities which have a more attractive regulatory and operating environment than water.

ASSET ALLOCATION

UK		The UK market continues to look cheap, with several FTSE companies the subject of takeover bids of late. First quarter GDP growth of 0.6% surprised to the upside, lifting the UK out of a technical recession. Furthermore, UK inflation continues to converge with the target of 2%. The suggestion now is that the Bank of England will cut interest rates before the Federal Reserve, with traders pricing in the first cut at either of the next two Monetary Policy Committee meetings.
North America		Recent US inflation prints have exceeded consensus expectations, pointing to inflation being stickier than previously anticipated. Traders have scaled back bets on the pace of rate cuts, suggesting rates may have to be higher for longer to bring inflation back to the target level. In conjunction with this, US equity valuations are at a premium, with the S&P500 trading on a 22x forward price-earnings multiple. These considerations lead us to a neutral view on North America.
Europe		The expectation remains that the European Central Bank will commence rate cutting when it meets in June, though there is concern that the last leg down to 2% inflation may prove stickier than previously anticipated. After a period of stagnation, Eurozone GDP grew by 0.3% in Q1 with Germany recovering to 0.2% growth having contracted in the prior quarter. In addition, indicators such as the European Purchasing Managers’ Index point towards easing conditions for companies in the region.
Japan		The Yen slid to a 34-year low against the dollar as the Bank of Japan voted to maintain interest rates in the 0.0-0.1% range. This reportedly led authorities to intervene in order to shore up the currency. The Nikkei 225 has pulled back from its all-time high, but improving corporate governance should continue to benefit Japanese equities.
Asia Pacific		Asia Pacific mostly revolves around China. The Chinese government appears confident that the economy is on course to achieve its 5% GDP growth target without a further stimulus package. However, underlying data releases, including retail sales and home prices, give some cause for alarm. Electric vehicle (EV) equities have been a bright spot in Chinese markets, though unsurprisingly the US has responded with significant import tariffs on Chinese-made EVs, further heightening tensions between the world’s two largest economies.
Emerging Markets		Higher-for-longer interest rates in the US should support continued dollar strength. A strong dollar is a headwind to dollar-exposed emerging market economies. We are still waiting to see how Javier Milei’s economic experiment in Argentina evolves. Equity valuations in emerging markets look reasonable on a relative basis, however dollar strength and geopolitical risk mean we retain our cautious view.

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