Global Asset Allocation Viewpoints

The last mile

4Q 2023

For public distribution in the United States. For institutional, professional, qualified and/or wholesale investor use only in other permitted jurisdictions as defined by local laws and regulations.

Key themes

Hover over each tile to read more about the quarter's key themes.

featured theme

Macro

Key takeaway

The global outlook looks troubled as rising rates, oil prices and the U.S. dollar threaten to exacerbate economic slowdowns.

Global economy: Starting to feel the heat

Although U.S. growth has exceeded expectations, with consumption headwinds building, growth is poised to decelerate. The convergence of rising interest rates, soaring oil prices, and a strengthening U.S. dollar has created a concerning growth scenario. Bond vigilantes have reacted to the prolonged period of higher interest rates, while supply cuts in the oil market have put upward pressure on prices. Additionally, the United States Federal Reserve's more hawkish stance compared to other central banks has bolstered the U.S. dollar's value. Collectively, these factors pose a risk to global economic growth, increase the likelihood of inflation, and threaten financial stress. Although there are a few positive aspects in the global economy, such as Japan's recovery from a prolonged period of lackluster growth and India's impressive growth trajectory, the global economic outlook remains weak.

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2019–present

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

Source: Federal Reserve, ICE Futures Europe, CME Group, Bloomberg, Principal Asset Management. Data as of September 30, 2023.

featured theme

Equities

Key takeaway

U.S. equities have already realized soft landing expectations but may be range-bound until clearer signs of economic slowdown emerge.

A soft landing is already priced in

After soaring in the first half of the year, U.S. equities struggled in 3Q. Early in the quarter, equities had performed well as strong reported earnings prompted upward revisions of 2024 earnings growth forecasts and firmed up soft landing expectations. Yet, the significant bond sell-off has challenged both stretched valuations and constructive macro views, resulting in a market pullback. With limited prospect of an upgrade to earnings expectations, equity market returns will likely be muted—particularly until bond yields peak. Once clear signs of earnings or economic slowdown emerge in late 2023 or even early 2024, equity markets may, at that point, come under renewed pressure.

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The market-weighted S&P 500 is outperforming the equal-weighted S&P 500 by 11%

the largest year-to-date outperformance since records began in 1990.

featured theme

Fixed income

Key takeaway

Current economic resilience is raising yields but offers valuable opportunities in bonds. Credit should continue to outperform until clear signs of economic weakness become evident.

Finally, some meat to eat

The "higher for longer" narrative, which led to sharply rising interest rates during 3Q, has acted as a significant headwind for the bond market. U.S. Treasurys have delivered -1.5% returns this year, down from a peak return of 4.2% in early April. The outlook for a U.S. economic slowdown in 2024 suggests that, eventually, U.S. Treasurys should deliver strong positive returns, while rising defaults may lead to stress in the lower-quality segments of the credit market. However, as clear signs of economic weakness may not be evident until early 2024, government bond yields may drift slightly higher in the near term, and credit is likely to continue outperforming. The bigger picture is that bonds can now generate more portfolio income than at any other time over the past 15 years. With investors today earning a higher yield on sovereign and high-grade corporate bonds than on equities, fixed income is finally more than just a diversification tool.

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Note: U.S. investment grade represented by the Bloomberg U.S. Corporate TR Value Unhedged USD Index. Source: S&P Dow Jones, Federal Reserve, Bloomberg, Principal Asset Management. Data as of September 30, 2023.

featured theme

Alternatives

Key takeaway

REITs have been challenged by the bond sell-off and are now deeply discounted. Once yields have peaked, REITS should offer a compelling opportunity.

REITs: The punches keep rolling

REITs have faced headwinds for the past 18 months and continue to be challenged, most recently by the sharp bond sell-off as hawkish central bank rhetoric prompted a reconsideration of the interest rate outlook. The likelihood of a credit crunch triggered by a banking crisis has further compounded the challenges faced by the real estate industry this year. With strict lending regulations and limited capital, the sector may continue to experience difficulties until the underlying issues are resolved. Until then, sluggish real estate transaction markets, pressure on capital values in the private market, and higher loan default risk for over leveraged properties are likely. As a result of these various factors, the REITs market is deeply discounted and, once rates have peaked, will likely present a compelling opportunity. Indeed, peaking or falling yields have historically been the catalyst for strong REIT market performance as investors typically look to rotate to longer duration, defensive assets.

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8.5%

total yields

at end of 2Q

While higher quality bonds will likely outperform and provide important diversification benefits, the mild recovery implies high yield (HY) defaults may not spike significantly, and elevated HY yields could provide decent cushion as spreads widen.

featured theme

Investment implications

Diversified asset allocation: Shifting to neutral as market uncertainties grow.

Investment preference, 4Q 2023

Less

Neutral

Fixed income

Alternatives

Equities

Our equities positioning shifts to neutral. Markets have already seen a pullback and, provided the bond yield sell-off is almost over, should settle into a flat range until macro weakness becomes apparent later this year or early 2024. Within U.S. equities, large-cap valuations remain stretched. However, we retain a preference for large- over small-cap, given the increasing need for quality, large balance sheets and pricing power, as well as the secular AI trend. Our exposure to ex-U.S. developed markets drops to underweight as concerns about European growth overwhelm our strong optimism for Japan. By contrast, we increased our exposure to emerging markets to a very slight overweight. China’s recovery continues to disappoint, but other EM markets are demonstrating strong valuations, strong fundamentals, or both.

how to implement

• Large-cap U.S. strategies • Quality-biased active managers • Well-diversified and active international managers

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Current quarter (4Q)

Last quarter (3Q)

Less

Neutral

Large-cap

Mid-cap

Small-cap

Ex-U.S.

Europe

U.K.

Japan

Developed Asia Pacific ex-Japan

Emerging Markets

key

Viewpoints reflect a 12-month horizon

indicates a change in preference from the previous quarter (light blue) to the current quarter (dark blue).

Index descriptions

Important information

MSCI Brazil Index is designed to measure the performance of the large and mid cap segments of the Brazilian market. MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). MSCI EAFE Index is listed for foreign stock funds (EAFE refers to Europe, Australasia, and Far East). Widely accepted as a benchmark for international stock performance, the EAFE Index is an aggregate of 21 individual country indexes. MSCI Emerging Markets Index consists of large and mid cap companies across 24 countries and represents 10% of the world market capitalization. The index covers approximately 85% of the free float-adjusted market capitalization in each country in each of the 24 countries. MSCI Europe Index captures large and mid cap representation across 15 Developed Markets (DM) countries in Europe. MSCI Europe Banks Index is composed of large and mid cap stocks across 15 Developed Markets countries in Europe. All securities in the index are classified in the Banks industry group (within the Financials sector) according to the Global Industry Classification Standard (GICS®). MSCI Germany Index is designed to measure the performance of the large and mid cap segments of the German market. MSCI India Index is designed to measure the performance of the large and mid cap segments of the Indian market. MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. MSCI USA Growth Index captures large and mid cap securities exhibiting overall growth style characteristics in the U.S. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. MSCI USA Index is a market capitalization weighted index designed to measure the performance of equity securities in the top 85% by market capitalization of equity securities listed on stock exchanges in the United States. MSCI USA Large Cap Index is designed to measure the performance of the large cap segments of the U.S. market. MSCI USA Mid Cap Index is designed to measure the performance of the mid cap segments of the U.S. market. MSCI USA Quality Index aims to capture the performance of quality growth stocks by identifying stocks with high quality scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. The MSCI Quality Indexes complement existing MSCI Factor Indexes and can provide an effective diversification role in a portfolio of factor strategies. MSCI USA Small Cap Index is designed to measure the performance of the small cap segment of the U.S. equity market. MSCI USA Value Index captures large and mid cap U.S. securities exhibiting overall value style characteristics. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield. Russell 2000 Index is a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index. Standard & Poor's 500 Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to a basket of foreign currencies. Market indices have been provided for comparison purposes only. They are unmanaged and do not reflect any fees or expenses. Individuals cannot invest directly in an index.

Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities, is disseminated real-time on a price-return basis (AMZ) and on a total-return basis (AMZX). Bloomberg Commodity Total Return index is composed of futures contracts and reflects the returns on a fully collateralized investment in the BCOM. This combines the returns of the BCOM with the returns on cash collateral invested in 13 week (3 Month) U.S. Treasury Bills Bloomberg Global Aggregate Bond Index comprises global investment grade debt including treasuries, government-related, corporate, and securitized fixed-rate bonds from developed and emerging market issuers. There are four regional aggregate benchmarks that largely comprise the Global Aggregate Index: the US Aggregate, the Pan-European Aggregate, the Asian-Pacific Aggregate, and the Canadian Aggregate Indices. The Index also includes Eurodollar, Euro-Yen, and 144A Index-eligible securities and debt from other local currency markets not tracked by regional aggregate benchmarks Bloomberg U.S. Agency Bond Index is composed of agency securities that are publicly issued by U.S. government agencies, and corporate and non-U.S. debt guaranteed by the U.S. government. Bloomberg U.S. Aggregate Bond Index is the most widely followed broad market U.S. bond index. It measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Bloomberg U.S. High-Yield Corporate Bond Index is a rules-based, market-value-weighted index engineered to measure publicly issued non-investment grade USD fixed-rate, taxable and corporate bonds. Bloomberg U.S. Corp High Yield 2% Issuer Capped Index is an unmanaged index comprised of fixed rate, non-investment grade debt securities that are dollar denominated. The index limits the maximum exposure to any one issuer to 2%. Bloomberg U.S. Corporate Investment Grade Index includes publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity and quality requirements. To qualify, bonds must be SEC-registered. The corporate sectors are industrial, utility and finance, which include both U.S. and non-U.S. corporations. Bloomberg U.S. Treasury Index measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury. Treasury bills are excluded by the maturity constraint. STRIPS are excluded from the index because their inclusion would result in double-counting. FTSE Global Core Infrastructure 50/50 Total Return Index comprises securities in developed countries which provide exposure to core infrastructure businesses, namely transportation, energy and telecommunications, as defined by FTSE's International Benchmark Classification. The FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs. HFRI 500 Fund Weighted Composite Index is a global, equal-weighted index of the largest hedge funds that report to the HFR Database which are open to new investments and offer quarterly liquidity or better. ICE BofA Emerging Markets Corporate Plus Index, which tracks the performance of US dollar (USD) and Euro denominated emerging markets non-sovereign debt publicly issued within the major domestic and Eurobond markets. ICE BofA U.S. High Yield Index tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market. ICE BofA U.S. Investment Grade Institutional Capital Securities Index tracks the performance of US dollar denominated investment grade hybrid capital corporate and preferred securities publicly issued in the US domestic market. ICE BofA U.S. Corporate Index consists of investment-grade corporate bonds that have a remaining maturity of greater than or equal to one year and have $250 million or more of outstanding face value. J.P. Morgan Emerging Markets Bond Index Global Core tracks liquid, U.S. dollar emerging market fixed and floating-rate debt instruments issued by sovereign and quasi sovereign entities. ISM manufacturing index is a leading economic indicator that measures the growth in the manufacturing sector in the United States. MSCI ACWI Index includes large and mid cap stocks across developed and emerging market countries. MSCI ACWI Utilities Index captures large and mid cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries*. All securities in the index are classified in the Utilities sector as per the Global Industry Classification Standard (GICS®). Market indices have been provided for comparison purposes only. They are unmanaged and do not reflect any fees or expenses. Individuals cannot invest directly in an index.

Index descriptions

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Risk considerations Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. Asset allocation and diversification do not ensure a profit or protect against a loss. Equity investments involve greater risk, including higher volatility, than fixed-income investments. Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline. International and global investing involves greater risks such as currency fluctuations, political/social instability and differing accounting standards. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. Non-investment grade securities offer a potentially higher yield but carry a greater degree of risk. Risks of preferred securities differ from risks inherent in other investments. In particular, in a bankruptcy preferred securities are senior to common stock but subordinate to other corporate debt. Emerging market debt may be subject to heightened default and liquidity risk. Risk is magnified in emerging markets, which may lack established legal, political, business, or social structures to support securities markets. Small and mid-cap stocks may have additional risks including greater price volatility. Treasury inflation-protected securities (TIPS) are a type of Treasury security issued by the U.S. government. TIPS are indexed to inflation in order to help investors from a decline in the purchasing power of their money. As inflation rises, rather than their yield increasing, TIPS instead adjust in price (principal amount) in order to maintain their real value. Inflation and other economic cycles and conditions are difficult to predict and there Is no guarantee that any inflation mitigation/protection strategy will be successful. Contingent Capitals Securities may have substantially greater risk than other securities in times of financial stress. An issuer or regulator’s decision to write down, write off or convert a CoCo may result in complete loss on an investment. Real assets include but not limited to precious metals, commodities, real estate, land, equipment, infrastructure, and natural resources. Each real asset is subject to its own unique investment risk and should be independently evaluated before investing. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Important Information This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice. The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account. Subject to any contrary provisions of applicable law, the investment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy and any responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided. This material may contain ‘forward-looking’ information that is not purely historical in nature and may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Important information

Disclosures

Investment implications

Alternatives

Fixed income

Equities

Macro

Global Asset Allocation Viewpoints

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Equities face limited upside as a 2024 soft landing is already priced in.

Spiking bond yields are challenging the equity market’s soft landing assumption. With limited prospect of an upgrade to earnings expectations, equity market returns are likely to be muted—particularly until bond yields peak.

Global growth is facing a number of headwinds.

The global outlook is being troubled by rising rates, oil prices and the U.S. dollar, resulting in investor risk aversion. The U.S. faces a consumer-led downturn, although corporate balance sheet strength should ensure it is only mild.

The global bond sell-off is disruptive but adds much-needed income to fixed income.

A nuanced approach is required in fixed income. Higher for longer may extend the bond sell-off, but a modest economic downturn means credit spreads can remain fairly tight. Bonds now generate meaningful portfolio income.

Alternatives provide important diversification against traditional equities and fixed income.

Until bond yields peak, REITs may remain under pressure. Commodities’ strong performance may be sustained. While the less bearish economic outlook suggests infrastructure exposure is less crucial, inflation mitigation is still required.

Fixed income

Alternatives

Fixed income

Our fixed income positioning also shifts to neutral, mainly driven by our more cautious view on Treasurys. Although peak Fed rates and slowing growth should ultimately prompt a rally, other technical and secular forces are at work and suggest some potential further upside. We prefer credit over sovereigns, but within credit, we prefer high-quality over low-quality. As such, while investment grade remains at an overweight, high yield continues to sit at neutral. Local currency emerging market debt remains at an overweight as central bank rate cuts should enhance returns—but we acknowledge that the potent combination of spiking U.S. Treasury yields and further dollar strength would dull the outlook.

how to implement

• IG credit heavy core fixed income for stability • Agency MBS strategies • Active emerging market debt

Current quarter (4Q)

Last quarter (3Q)

Alternatives

Alternatives remain at a neutral weighting. Commodities and natural resources move to neutral as the outlook for oil prices remains fairly constructive in light of supply cuts. The more resilient economic backdrop prompts a reduction in our long-held overweight exposure to infrastructure, although the still sticky inflation environment implies inflation protection is still required. REITs valuations have improved significantly, suggesting upside if and when central bank rates peak, and economic growth slows. Yet, until global bonds hit a ceiling, we keep REITs at a neutral. Alternatives continue to play a vital diversification role, particularly against elevated macro volatility.

how to implement

• Diversified real asset strategies (Infrastructure, natural resources)

Current quarter (4Q)

Last quarter (3Q)

Less

Neutral

Equities

Key themes

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Coming Soon

01

Equities face limited upside as a 2024 soft landing is already priced in.

02 The global bond sell-off is disruptive but adds much-needed income to fixed income.

03 Alternatives provide important diversification against traditional equities and fixed income.

04

how to implement

• IG credit heavy core fixed income for stability • Agency MBS strategies • Active emerging market debt

Contact your rep

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Equities

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Neutral

how to implement

• Diversified real asset strategies (Infrastructure, natural resources) • Private real estate markets

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Current Quarter (4Q)

Last Quarter (3Q)

Commodities

Natural resources

Infrastructure

REITs

Hedge Funds

U.S. 10-year Treasury yield, Brent crude oil price and U.S. dollar index

Yield comparison: S&P 500, investment grade bonds, and 6-month Treasury bills

S&P 500 12m forward earnings yield, investment grade bond yield-to-worst, and 6-month Treasury bills yield

Treasurys

Mortgages

Investment grade corporates

High yield/Senior loans

Preferreds (debt & equity)

TIPS

Ex-U.S.

Developed market sovereigns

Developed market credit

Emerging market local currency

Emerging market hard currency

Natural resources

Infrastructure

REITs

Hedge funds

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Neutral

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Investment Preference, 3Q 2023

The stock market and earnings

S&P 500 Index price and trailing earnings-per-share, 1990–present

Source: Clearnomics, Standard & Poor’s, Bloomberg, Principal Asset Management. Data as of September 30, 2023.

Public REIT performance during various rate environments

Cumulative return

Source: FactSet, Principal Real Estate. Returns data is showing FTSE EPRA/NAREIT Developed index (global REITs) average cumulative total returns and excess returns over the MSCI World (global equities) and FTSE NAREIT Equity REITs (U.S. REITs) over the S&P 500 (U.S. equities) during the last 7 periods of rising real yields (an increase of at least 75 bps represented by the U.S. 10-year TIPS) and during the 12 months after the peak of the rising rate period. Past performance does not guarantee future results. Indices are unmanaged and do not take into account fees, expenses, and transaction costs and it is not possible to invest in an index. Data as of June 30, 2023.

2019 2020 2021 2022 2023

$140 $120 $100 $80 $60 $40 $20 $0

115 110 105 100 95 90 85

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500

$200 $150 $100 $50 $0

1995 2000 2005 2010 2015 2020

U.S. 10-year Treasury yield (LHS)

Brent crude oil, US$/bbl (RHS)

U.S. dollar (outer RHS)

115 110 105 100 95 90 85

S&P 500 Index (LHS)

S&P 500 EPS (RHS)

Tech bubble peak: 1,527 EPS $53

Housing bubble peak: 1,565 EPS $93

Sept. 30, 2023: 4,288 EPS $217

Hover over key to isolate

8% 7% 6% 5% 4% 3% 2% 1% 0%

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

6m Treasury bill

U.S. investment grade

S&P 500

$140 $120 $100 $80 $60 $40 $20 $0

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500

$200 $150 $100 $50 $0

Global REITs

U.S. REITs

25% 20% 15% 10% 5% 0% -5% -10% -15% -20%

Returns when rates are rising

Returns vs equities during rising rates

Average 12m returns after peak rates

Average 12m returns vs equities after peak rates

-0.9%

-2.7%

-10.4%

-13.5%

20.1%

18.3%

8.3%

6.9%

2019–present

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

115 110 105 100 95 90 85

$140 $120 $100 $80 $60 $40 $20 $0

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500

1995 2000 2005 2010 2015 2020

$200 $150 $100 $50 $0

Tech bubble peak: 1,527 EPS $53

Housing bubble peak: 1,565 EPS $93

Sept. 30, 2023: 4,288 EPS $217

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

8% 7% 6% 5% 4% 3% 2% 1% 0%

25% 20% 15% 10% 5% 0% -5% -10% -15% -20%

For more macro insights, access our Viewpoints.

For more equities insights, access our Viewpoints.

For more fixed income insights, access our Viewpoints.

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For more alternatives insights, access our Viewpoints.

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For more macro insights, access our Viewpoints.

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Less

Neutral

Treasurys

Mortgages

Investment grade corporates

Preferreds (debt & equity)

TIPS

Developed market sovereigns

Developed market credit

Emerging market local currency

High yield/Senior loans

Ex-U.S.

Emerging market hard currency

Viewpoints reflect a 12-month horizon

indicates a change in preference from the previous quarter (light blue) to the current quarter (dark blue).

Source: Principal Asset Allocation. Alternatives asset class include commodities, natural resources, infrastructure, REITs, and hedge funds. Allocations across the investment outlook can be proportionately adjusted so magnitudes across categories do not have to net to neutral. Data as of September 30, 2023.

• Private real estate markets

CIO, Asset Allocation

Todd Jablonski, CFA

Director, Global Strategist

Garrett Roche, CFA, FRM

Director, Global Insights & Content Strategy

Brian Skocypec, CIMA

Chief Global Strategist

Seema Shah

Director, Quantitative Strategist

Han Peng, CFA

Insights Strategist

Ben Brandsgard

Principal Global Insights Team

Insights team

Recorded April 18, 2023

What should investors expect from markets and the economy in the fourth quarter and beyond? Listen as Seema Shah, Chief Global Strategist and Todd Jablonski, Chief Investment Officer & Head of Asset Allocation share their perspectives including key investment themes and asset allocation preferences.

4Q GAAV video presentation

What should investors expect from markets and the economy in the fourth quarter and beyond? Listen as Seema Shah, Chief Global Strategist and Todd Jablonski, Chief Investment Officer & Head of Asset Allocation share their perspectives including key investment themes and asset allocation preferences.

Recorded April 18, 2023