Quarterly Asset Allocation - Q2 2021

2Q Investment Outlook: Overweight Equities and Slightly Underweight Bonds

Q: Principal Asset Management (Asia) Investment Management Team

A: Crystal Chan, Senior Investment Specialist of Principal Asset Management (Asia)

Q:Entering the second quarter, how have the fundamental factors changed?

A: More doses of Covid-19 vaccines have been administered. Among the countries/regions in the world, Israel has the highest rate of vaccination, followed by the United Kingdom and the United States. Based on the current US vaccination rate, it is possible that three quarters of the population will have completed two doses of vaccine by the middle of the third quarter. As a result, the number of daily new cases around the world has also dropped significantly. Taking the United States as an example, the number of cases dropped by more than 80% at the peak.

In terms of the economy, the global manufacturing PMI has returned to a three-year high; the global financial conditions index has remained in the loosest territory on record. With the support of large-scale accommodative fiscal and monetary policies, global economic output may return to pre-pandemic levels this quarter.

Q:What are the risks that the investment market is facing?

A:In the short term, rising inflation and an excessive surge in long-term yields are still the biggest risks that the investment market is facing. As food and energy prices rise further, inflation is expected to continue to heat up during the year, triggering market concerns about an early shift in monetary policy. However, the Fed has stated that it will follow the new average inflation target framework. Therefore, even if core inflation rises, it is more likely to be seen as evidence of a gradual economic recovery. The policy rates may remain unchanged from now until 2023.

Surging inflation expectations and real interest rates have driven the 10-year bond yield to reach a record high in more than a year. U.S. Treasury bond yields are generally regarded as risk-free interest rates. Rising U.S. bond yields, especially 10-year Treasury bond yields, may increase financing costs for governments, corporates and individuals, and put pressure on the financial market. In addition, the earnings yield of the equity market may also be affected, reducing the attractiveness of high valuation stocks.

Q:How should assets be allocated in 2Q?

A: We believe that the basic factors driving the market upward have not changed. In the second quarter, we continue to be optimistic on equities. Among them, Asia is bullish, while the United States, Japan and Hong Kong are slightly bullish, China is neutral, and Europe is slightly bearish.

In terms of bonds, we are slightly bearish overall, and recommend cutting down the duration. Based on the expectation that the yield curve will continue to steepen; we are bearish on sovereign bonds, while investment-grade bonds are neutral.

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Crystal Chan
Senior Investment Specialist
Principal Asset Management (Asia)

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