Valuable insights into global markets can be obtained from Citi’s recent global asset allocation report issued last week.

Asset allocation

Asset allocation: Key focus

Asset prices did well following the ‘no-taper,’ but Citi continues to prefer equity to fixed income. The rally in U.S. treasuries will probably fizzle once tapering begins in earnest. According to Citi economists, cumulative probabilities for tapering starting October is 15%, December 50% and in January 80%.

Equities, however, are not all painted with the same brush – emerging markets remain risky, while Japanese stocks are highly volatile. Citi prefers European equities to U.S.

Asset allocation risks

Risks to be kept in mind are

  • monetary policy changes in developed and emerging markets
  • debt ceiling problems emanating from the U.S.
  • geo-political risks such as the Middle East and
  • credit bubbles in China/Asia and fragile status of the emerging markets

Asset class drivers

Equities stand to gain from better macro economic conditions, improving earnings and a re-rating due to higher investor flows. Also, corporates are taking advantage of a low interest rate environment to raise funds on the cheap and use them for shareholder friendly applications such as buybacks, dividends, PE buyouts and M&A. These funds, flowing to investors, may find their way back into the equity markets.

Commodities are likely to under-perform due to sluggish demand and higher supply.

On FX, the U.S. Dollar is likely to trend weaker.

Bonds are likely to sell off the most in the U.S. while German and European bonds would do well. Emerging market bonds would be pressured due to rising rates on U.S. Treasuries and volatile currencies.

Credit is likely to see further spread compression until mid-2014.

Asset positioning

Short term:

Overweight – US and European equities, European bonds

Neutral – Japanese and EM equity, corporate credit, government bonds (except EU), commodities (except PM)

Underweight – UK bonds, precious metals, cash

Medium term:

Overweight – European equities, corporate credit (European HY only), commodities (energy only)

Neutral – Other corporate credit, bonds (Europe, Germany, and EM local), commodities (except energy), cash

Underweight – US, UK and Japanese bonds

Here is a pictorial representation of Citi’s asset allocation strategy:

asset allocation map