Time is running out
Global Asset Allocation Viewpoints
3Q 2023
Inflation is decelerating, but at a slow pace, and will end the year meaningfully above target.
Headline inflation is falling rapidly, but core inflation is proving to be a worry in developed markets (DM). Slower economic growth will be required to reach global central bank inflation targets. By contrast, emerging market (EM) inflation has fallen below DM inflation.
Hover over each title to learn more about our key themes.
Key Themes
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While manufacturing has struggled, global growth has been supported by the services sector. Despite resilient U.S. growth, the foundations have been laid for a short and shallow recession later this year.
Europe is weakening, China is disappointing, and the U.S. is approaching recession.
Stubborn core inflation has led to a repricing of central bank rate hikes, with further hikes to come in most DM economies, including the Federal Reserve (Fed). Inflation caution also implies that rate cuts will not start in 2023.
Most central banks are not done with monetary tightening; rate cuts off the agenda in DM.
Inflation is decelerating but remains sticky and elevated, so inflation mitigation via infrastructure remains crucial for investors.
By contrast, the slowing growth outlook will further depress commodities and natural resources.
Alternatives provide important diversification against traditional equities and fixed income.
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 a decent cushion as spreads widen.
High-quality fixed income offers stability and income in this unfolding economic backdrop.
Notably, as a U.S. recession will likely be short and shallow, any equity pullback will likely be short and shallow. The following recovery will likely be reasonably swift, requiring a nimble and active response from investors.
Equities will come under pressure as earnings weaken and further rate hikes test valuations.
Financial conditions are overdue a reversal
Lessons from the 70s: No space for rate cuts in 2023
Central bank tightening: Not the end of the road
just yet
Global disinflation dispersion
Recession: Stop me if you’ve heard this one...
Global economy:
Shades of grey
Source: Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Principal Asset Allocation Financial Conditions Index (FCI), Z-score, 2005–present
• Despite continued rate hikes and the threat of recession, global financial conditions loosened in 2Q.
• However, optimistic growth expectations need to be questioned now that risks have swung towards higher terminal policy rates. As a result, market sentiment is beginning to look vulnerable, with DM financial conditions likely to tighten in the second half of 2023.
• The emerging market financial conditions picture may look more constructive. Falling central bank rates in many EM economies should cushion them from the broad deterioration in global growth and market sentiment. For China, however, policy rate cuts may not be enough to offset the weakness in growth, suggesting China’s risk assets may continue to struggle.
Developed market and emerging market financial conditions
Now that risks have swung towards higher terminal rates, market sentiment is beginning to look vulnerable and financial conditions are overdue a tightening trend.
Key insight
Financial conditions are overdue a reversal
Source: Bureau of Labor Statistics, Bloomberg, Principal Asset Management. Data as of July 12, 2023.
Consumer Price Index (CPI)
• The striking similarities between U.S. inflation developments today and those of the early 1970s could be instructive for the path forward.
• During the inflation spike of that period, the Fed also responded with steep interest rate hikes. After some time, the Fed was anxious to ease monetary policy, cutting interest rates before inflation had fallen back to levels consistent with price stability. The result was a resurgence in price pressures.
• Lowering interest rates before the Fed is confident that inflation is on a sustainable path back to 2% would threaten to undo all its hard work to date, ultimately requiring more aggressive hikes next year.
Historical inflation comparison
The risks associated with premature rate cuts are significant. The Fed would need to see a desperately struggling economy or a financial crisis to justify rate cuts this year.
Key insight
Lessons from the 70s: No space for rate cuts in 2023
European Central Bank rates path
Federal Reserve rates path
• Both the ECB and the Bank of England (BoE) have inflation challenges.
• For the ECB, this implies hikes may persist into Autumn.
• For the BoE, policy rates will likely rise another 100 basis points and may exceed 6%, raising the risk of recession.
Source: Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Future market priced ECB rates path as of March 31 vs. June 30
Federal Reserve rates path
European Central Bank rates path
Source: Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Future market priced fed funds rates path as of March 31 vs. June 30
• During early 2Q, broad market consensus converged around the idea that global monetary loosening would start before year-end, with this expectation lifting risky assets.
• However, it has become clear that rate hikes are yet to have the desired impact on inflation, requiring further tightening.
• The Fed’s latest dot pot shows that most committee members expect at least two more hikes this year. By contrast, with modest recession on the horizon, our long-held Fed forecast sees just one more increase, bringing policy rates to a peak of 5.25%-5.50%.
Inflation persistence means that markets need to raise their developed market rate expectations, and also price out any rate cuts this year.
Key insight
Central bank tightening: Not the end of the road just yet
Contribution to headline U.S. inflation
Principal Asset Allocation GDP-weighted inflation
• U.S. core inflation has fallen only slightly, and monthly core inflation is essentially unchanged from late-2022.
• Core commodities inflation in the U.S. is expected to fall further, given the ongoing weakness in goods demand, and shelter inflation should begin to abate slowly.
• The concern lies in the very slow deceleration of core services ex-housing. If the labor market remains extremely tight, inflation in this critical segment will remain too high for the Fed’s comfort, and the disinflation trend will be incomplete.
Source: Bureau of Labor Statistics, Principal Asset Management. Data as of July 12, 2023.
Year-over-year, 2015–present
Principal Asset Allocation GDP-weighted inflation
Contribution to headline U.S. inflation
Source: Bloomberg, Principal Asset Allocation. Data as of July 12, 2023.
January 2007–present
• Global headline inflation continues to moderate, helped along by falling energy prices. However, developed market core inflation remains very elevated.
• Euro-area core inflation has only just peaked, and price pressures remain very broad across the economy.
• UK core inflation is still yet to peak.
• Japan’s inflation is broadening, reaching healthier levels.
• By contrast, China’s consumer prices are barely increasing, and emerging market inflation actually fell below developed market inflation in April.
DM central banks have made less progress towards disinflation than they had hoped. Inflation is likely to remain sticky and will still sit above global central bank targets at year-end.
Key insight
Global disinflation dispersion
Small business credit conditions and initial jobless claims
Aggregate excess savings following recession
• Labor demand has been robust, but a softening trend is tentatively beginning to emerge, with monthly non-farm payrolls falling to their lowest level since COVID. Average hours worked have been drifting lower, jobless claims are on the rise. These are leading indicators of job losses.
• The recent banking crisis will likely further deteriorate the economic picture. Tightening credit conditions usually act as an accelerant to the unwind in both consumer spending and the labor market.
Source: NFIB, Bureau of Labor Statistics, Bloomberg, Principal Asset Management. Data as of July 11, 2023.
1986–present
Aggregate excess savings following submission
Small business credit conditions and initial jobless claims
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Trillions, months since start of recession
• Despite significant monetary tightening, incoming U.S. economic activity data is nowhere near recessionary. Yet, this doesn’t mean that interest rate hikes aren’t working.
• Policy works with lags, and the full impact of previous hikes is only now starting to unfold.
• Consumer activity has been strongly supported by the historically large excess savings cushion. However, savings are gradually being eroded by exuberant spending, inflation, mortgage costs, and time. At the current pace of drawdown, excess savings will be exhausted by 4Q 2023, removing a major support structure for the U.S. economy.
Deterioration in both consumer spending and labor market activity will likely precipitate the arrival of one of the most anticipated recessions in history.
Key insight
Recession: Stop me if you’ve heard this one before…
U.S. recession probability in next 12 months
Developed market and China Purchasing Managers’ Index (PMI)
• In the U.S., recession risk remains heightened, with concerns centering around profit margin compression and tightening credit conditions.
• Indeed, while the continued resilience of consumers and the labor market suggest that a U.S. recession is not imminent, leading indicators almost uniformly signal slowing economic growth as the full effects of significant and aggressive Fed tightening are finally felt.
Source: Federal Reserve Bank of New York, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Federal Reserve Bank of New York, 1960–present
Developed market and China Purchasing
Managers’ Index (PMI)
U.S. recession probability in next 12 months
Source: Bloomberg, Principal Asset Allocation. Data as of May 31, 2023.
May 2008 – May 2023
• In the face of multiple and significant headwinds, global economic growth has proved resilient.
• Regionally, there is some divergence. While U.S. growth has remained robust, the European economy fell into recession at the end of 2022, and China’s post-reopening economic recovery has lost significant momentum.
• The outlook for the rest of the year is relatively downbeat. Europe’s growth is set to slow, with recovery likely to be limited by tight European Central Bank (ECB) monetary policy. In China, in the absence of significant and proactive policy stimulus, activity will likely remain somewhat depressed.
With the three largest economies facing varying levels of slowdown, the global growth outlook has deteriorated.
Key insight
Global economy:
Shades of grey
Europe’s and (especially) Japan’s reversal in fortunes
Looking at EM equities through a non-China lens
Bad breadth and narrow market leadership
U.S. equities defy rate hikes and recession concerns
Global equity valuations are becoming more stretched
Cumulative foreign flows into Japan equities
MSCI Europe and Germany industrial manufacturing orders
• Japan’s economy is experiencing a revival, with inflation and wage growth returning to healthier levels.
• Following its central bank peers, the Bank of Japan is widely expected to shift away from ultra-easy monetary policy in response to higher inflation.
• Potential strengthening in the Japanese yen will likely attract global investor attention, adding to returns for USD-based investors. Japan also provides an attractive opportunity for diversification, given that its economic cycle appears desynchronized from other DMs.
Source: Japan Ministry of Finance, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Billions, 2012–present
MSCI Europe and Germany industrial manufacturing orders
Cumulative foreign flows into Japan equities
Source: MSCI Inc., Deutsche Bundesbank, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Level, 2003–present
• The euro area and Japan have enjoyed a reversal in fortunes this year, attracting significant inflows following years of investor disinterest. Yet, while the outlook for Japanese equities in 2H 2023 looks bright, Europe’s outlook is less promising.
• Positive expectations for China’s reopening had previously lifted European equities, but China’s recovery has lost momentum and is potentially becoming a drag for Europe.
• European inflation, too, remains a significant problem, and the ECB’s hawkish response will weigh on European growth. However, the ECB’s relative hawkishness is bolstering the euro, adding to potential returns for USD-based investors.
Japan is enjoying an economic revival. Healthier inflation prospects will likely trigger BoJ tightening, bolstering the yen and adding to returns for USD based investors.
Key insight
Europe’s and (especially) Japan’s reversal in fortunes
China imports in 2022
People's Bank of China historical rate cuts
• There are some clear positives within EM Asia and Latin America beyond China.
• Emerging markets ex-China economies have generally proved stronger than DM economies, inflation is normalizing faster, and several EM central banks are primed to start cutting rates in the near future.
• In Latin America, for example, fundamentals are improving just as valuations are running below their historical averages—an attractive investment combination.
Source: Bloomberg, Principal Asset Management. Data as of December 31, 2022.
Share of key import regions, calendar year 2022
People's Bank of China historical rate cuts
China imports in 2022
Source: People’s Bank of China, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
September 2019–present
• The Chinese economy hit a wall in 2Q as recovery momentum lost significant steam. Aggregate financing activity in China also disappointed after an initial surge.
• With economic weakness widely recognized by policymakers, stimulative measures are likely to follow. The central bank has already reduced several policy rates, yet the magnitude of the moves has fallen short of market expectations.
• Modest stimulus may be sufficient to help ensure China hits its 5% GDP growth target for 2023, but more would be needed to trigger meaningful positive spillover effects to the rest of EM and other major trading partner.
China’s disappointing recovery means policymakers could roll out stimulus, but it may not be big enough to benefit wider EM.
However, there are positives within EM ex-China.
Key insight
Looking at EM equities through a non-China lens
S&P Technology price relative to S&P 500 price
S&P 500 sector YTD returns
• The outperformance of the S&P 500 Technology sector over the broader index is now higher than during the dot-com era.
• Such narrow market concentration is a potential concern for investors. Against a backdrop of further monetary tightening and economic slowdown, a broadening of the rally looks challenging.
• From here, if the few stocks driving the rally fail to deliver on elevated earnings expectations, the broad market will likely be exposed to a pullback.
Source: S&P Dow Jones, Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
1995–present
S&P 500 sector YTD returns
S&P Technology price relative to S&P 500 price
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Total return, January 2023–present
• While the S&P 500 has been on an impressive run, the rally has been driven by the explosive performance of only a handful of mega-cap stocks across the technology, consumer discretionary, and communications sectors—and all by companies firmly associated with AI excitement.
• Until mid-June, the five best-performing stocks in the S&P 500 had contributed 60% to returns this year (compared to an average positive contribution of 35% over the past decade).
• 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.
The narrowness of the U.S. rally means that diversification via non-U.S. equities, which have lower tech concentration and are less correlated to the AI excitement, may be warranted.
Key insight
Bad breadth and
narrow market
leadership
While U.S. equities are vulnerable to earnings disappointment, the short and shallow nature of recession implies any pullback will be equally short and shallow.
Key insight
U.S. equities defy rate hikes and recession concerns
Source: FactSet, Bloomberg, MSCI, Principal Asset Allocation. LTM (last twelve months) returns are total return and in USD terms. % Time Cheaper is relative to PAA Equity Composite Valuation history. PAA Equity Composite Valuation is a calculated measure, comprised of 60% price-to-earnings, 20% price-to-book and 20% to dividend yield. Composite started in 2003. EAFE is Europe, Australasia, Far East. See disclosures for index descriptions. Data as of June 30, 2023.
Last twelve months returns and % times cheaper, MSCI indices
• Global equities delivered a strong performance in 2Q, helped by earnings resilience and a spectacular tech rally.
• While fading hopes of China’s recovery have erased all their equity gains since January, the rest of emerging markets held up well.
• European equities lost steam as 2Q progressed, in line with China’s growth weakness. Japanese equities rallied on the back of reflation momentum and currency tailwinds.
• Emerging markets can also be considered cheap, driven by significantly discounted valuations in Latin America.
• As a result, global valuations became more stretched. U.S. large-cap and growth remained the most expensive markets, while valuations in most other regions remained around or below their historical medians.
Global equity returns and valuations
After 2Q’s rally, global equity valuations have become more stretched. The U.S. remains the most expensive market, while Latin America has rarely been cheaper.
Key insight
Global equity valuations are becoming more stretched
Click the cards below to learn about each equities investment theme
Equities
EM debt: Improved outlook but with lingering risks
High yield: A robust picture amidst economic weakness
Navigate credit headwinds with high-quality assets
U.S. Treasurys:
An important role in portolios
Fixed income: Interest rate risk is favorable to equity risk
Emerging market debt versus U.S. dollar
GDP-weighted real policy rates
• In a steadier/weaker USD environment, EM currencies should begin to regain ground.
• Of course, despite the relative attractiveness, EMD is not risk-free. A deep liquidity crisis or deeper recession in the U.S. could significantly impact EMD.
Source: JP Morgan, CME group, Principal Asset Management. Data as of June 30, 2023.
2018–present
GDP-weighted real policy rates
Emerging market debt versus U.S. dollar
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Policy rates minus CPI YoY, GDP weighted, 2007–present
• A mild U.S. recession outlook and desynchronized economic cycles suggest EMD may escape the downturn relatively unscathed.
• Many emerging market central banks were ahead of their developed market peers in hiking rates, successfully reining in inflation sooner. This position has allowed them to shift to a more dovish stance, with many considering rate cuts from very high levels. Such a policy change would likely provide attractive yields and enhanced returns on local currency bonds.
• In fact, GDP-weighted real policy rates for EM are above zero, while developed markets' rates remain in negative territory.
Emerging market debt could escape mostly unscathed in a mild U.S. recession. Faster inflation normalization in EM is allowing their central banks to start shifting to rate cuts.
Key insight
EM debt: Improved outlook but with lingering risks
High yield quality composition
Historical high yield spreads
• Overall, the asset class is better positioned now compared to previous economic down cycles.
• The recession is expected to be mild, implying that the default spike could be lower.
• The credit quality of the high yield index today is well above its historical average.
• Near-term refinancing pressure is low. The maturity wall remains low in 2023 and will likely only build in 2024-2025.
Source: BlackRock Aladdin, Principal Asset Management. Data as of June 30, 2023.
Bloomberg U.S. Corporate HY 2% Issuer Capped Index, 2015–present
Historical high yield spreads
High yield quality composition
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Axis crosses at June 2023 value, 2000–present
• High yield spreads have tightened significantly since their peak in March and are now pricing in a soft-landing for the U.S. economy.
• Historically, periods where the asset class experienced tighter spreads than it is currently were characterized by economic expansions or a dovish Fed.
• Nonetheless, with total yields an attractive 8.5% at the end of 2Q, high yield investors would have a decent cushion if spreads were to unwind during the coming economic downturn.
High yield is well positioned given the mild recession outlook, its better credit quality, and low near-term maturity pressure. Despite rich valuations, carry is very attractive.
Key insight
High yield: A robust picture amidst economic weakness
High yield minus investment grade spreads
versus Senior Officer Loan Survey
High yield minus investment grade
spreads versus ISM Manufacturing PMI
• Higher-risk credit markets don’t appear to be pricing in potential financial stress or economic downturns, and investors should be wary.
• In addition to the spread impact, high-quality bonds also benefit from longer duration.
• During economic downturns, falling treasury yields typically result in greater price gains for investment grade credit due to investment grade's higher duration versus high yield bonds.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
U.S. recessions are shaded, 2000–present
High yield minus investment grade
spreads versus ISM Manufacturing PMI
High yield minus investment grade spreads
versus Senior Officer Loan Survey
Source: Institute for Supply Management, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
U.S. recessions are shaded, 2000–present
• High-quality bonds underperformed low-quality bonds in 2Q as fears around the regional banking crisis and debt ceiling impasse eased.
• With soft-landing hopes increasing, investors are becoming more optimistic about high yield relative to investment grade.
Higher-quality fixed income assets should outperform in economic downturns, benefitting from tighter spreads and longer duration.
Key insight
Navigate credit headwinds with
high-quality assets
S&P 500 versus Bloomberg Treasury Index correlation
10-year Treasury and the ISM Manufacturing Index
• As the stock-bond correlation has turned negative, U.S. Treasurys are providing important diversification benefits and risk mitigation.
• While equities are likely to face earnings headwinds from a slowing U.S. economy, bond yields should come under downward pressure as expectations for future interest rates are reduced, thereby providing capital appreciation to bondholders.
• As such, bonds can act as a hedge against volatility and equity drawdowns.
Note: Correlation is of 1-day returns, within a 120-day rolling window. Source: S&P Dow Jones, Federal Reserve, Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Rolling 120-day correlation, 2018–present
10-year Treasury and the ISM Manufacturing Index
S&P 500 versus Bloomberg Treasury Index correlation
Source: Institute for Supply Management, Standard & Poor's, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Year-over-year change, 1991–present
• With central bank policy rates at their highest in over a decade, the value provided by sovereign bonds, particularly U.S. Treasurys, has seldom been greater.
• Investors are getting much higher compensation for taking interest rate risk than in previous years.
As the economy slows, U.S. Treasurys will likely provide important security and diversification benefits, as well as capital appreciation.
Key insight
U.S. Treasurys:
An important role in portfolios
Equity versus bond volatility
Yield comparison: S&P 500, investment grade bonds, and 3-month Treasury bills
• In a slower growth environment, fixed income looks preferential to equities.
• Unlike bonds, equities don’t sufficiently account for recession risk, as evidenced by the subdued level of equity volatility relative to the elevated level of bond volatility.
• In fact, the earnings yield on stocks is now less than safer U.S. Treasurys and high-grade corporate bonds. Locking in more stable income streams and adding diversification via bonds will be prudent as an economic slowdown unfolds.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
2001–present
Yield comparison: S&P 500, investment grade bonds, and 3-month Treasury bills
Equity versus bond volatility
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 June 30, 2023.
S&P 500 earnings yield, investment grade bond YTW, and 3-month Treasury bills yield
• As concerns about the banking sector faded in 2Q and economic data showed resilience, future Fed rate cuts were pushed out to 2024—driving an underperformance in more stable assets relative to high yield credit and even equities.
• While this performance seems justified by current economic resilience, it conflicts with forward-looking indicators suggestive of future economic deterioration.
• As the lagged effects of central bank tightening begin to take their toll on credit conditions and the economy slows, recent buoyancy in equities and riskier credit sectors is likely to unwind, with higher defaults, downgrades, and widening credit spreads.
Investors are getting higher compensation for taking interest rate risk than equity risk. With the economy set to slow, there’s strong rationale for locking-in more stable fixed income streams.
Key insight
Fixed income: Interest rate risk is favorable to equity risk
Click the cards below to learn about each fixed income investment theme
Fixed Income
REITs vulnerable to recent banking sector strains
Infrastructure’s crucial defensive role in portfolios
Commodities: Short-term pain but long-term gain
Note: Data since 4Q 2013 is average of construction and land development, nonfarm nonresidential and multifamily. Source: Federal Reserve, Principal Asset Management. Data as of June 30, 2023.
Senior Loan Officer Opinion Survey on Bank Lending Practices, 1991–present
• REITs continue to be challenged, with office REITs, in particular, still struggling in the face of sluggish return-to-office trends and the tightening credit environment.
• However, REITs are likely approaching the bottom of their cycle. Traditional office space accounts for only 3% of the overall U.S. REIT market.
• Other non-traditional sectors, such as single-family rental, self-storage, and wireless towers, enjoy structural demand drivers and provide earnings resiliency.
• After some further adjustments, REIT valuations will likely start to look attractive again.
U.S. bank responses regarding commercial real estate loans
REITs are due for a further pullback. Yet, once valuations have reset, deteriorating economic fundamentals may signal a more positive story for REITs.
Key insight
REITs vulnerable to recent banking sector strains
Listed infrastructure versus global equities in years of higher inflation
Note: Global equities is represented by MSCI All Country World Index. Global listed Infrastructure is represented by the MSCI ACWI Utilities Index from 2003 through 2006, a 50/50 blend of MSCI ACWI Utilities Index and the Alerian MLP Index from 2007 through 2015, and the FTSE Global Core Infrastructure 50/50 Index thereafter. Past performance does not guarantee future results. Index performance information reflects no deduction for fees, expenses, or taxes. Indices are unmanaged and individuals cannot invest directly in an index. Source: U.S. Bureau of Labor Statistics, CPI ex-food & energy, FactSet, Principal Asset Management. Data as of December 31, 2022.
2003 - 2022
• A continued constructive view of listed infrastructure conveys its diversification benefits in this macro environment and its fundamental strengths and defensive characteristics.
• Listed infrastructure is one of the few asset classes that can potentially outperform in a slowing growth, sticky inflation environment.
• Indeed, listed infrastructure has historically delivered meaningfully higher returns than global equities during periods of elevated inflation.
• From a portfolio perspective, infrastructure investments can offer more stability, typically having predictable cash flows associated with the long-lived assets.
Infrastructure continues to offer important inflation mitigation and a more stable income stream.
Key insight
Infrastructure's crucial defensive role in portfolios
S&P Energy Capital Expenditure
Bloomberg Commodities Index and
South Korean trade exports in U.S. dollars
• The short-term outlook for natural resources has also declined.
• The equity beta component embedded in natural resources may result in further downside if the weakening economic backdrop weighs on the broader equity market.
• The long-term outlook, however, remains more constructive. Limited capital expenditure in fossil fuels capacity in recent years implies that commodities will likely remain in a long-term state of structural supply deficits that will support commodity prices.
Source: S&P Dow Jones, Macroeconomic Advisers, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Adjusted for U.S. nominal GDP, 1993–present
Bloomberg Commodities Index and
South Korean trade exports in U.S. dollars
S&P Energy Capital Expenditure
Source: Korean Ministry of Trade, Industry and Energy, Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
2002–present
• The prospect of a global economic slowdown will likely weigh further on commodity performance over the coming quarters.
• With China’s reopening losing significant momentum and policy stimulus underwhelming expectations, boosted commodity demand from Asia seems unlikely.
• In the U.S., despite a seemingly resilient economy, the foundations for a meaningful slowdown later this year are in place. So, while segments of the global economy look stronger, they will not be able to offset the reduced commodity demand from the world’s two largest economies.
The short-term commodity outlook is fairly weak as China growth concerns add to U.S. growth fears. By contrast, long-term trends are clearer and more constructive.
Key insight
Commodities: Short-term pain but long-term gain
Click the cards below to learn about each fixed income investment theme
Alternatives
Fixed income
Alternatives
Alternatives shift to neutral as, although they provide important diversification benefits, the outlook for specific segments has deteriorated. We shift our commodities and natural resources positions to underweight, concerned by the coming global growth slowdown and likely equity market downturn. REITs remain at underweight, given continued pressures on the real estate sector, particularly from the office space.
We shift hedge funds to neutral as volatility remains very subdued. By contrast, we maintain our overweight to infrastructure, encouraged by its inflation-protection characteristics, stability of cash flows, and exposure to the structural de-carbonization trend.
Investment viewpoints
• Diversified real asset strategies (infrastructure, natural resources)
• Private real estate markets
How to implement
Hedge funds
REITs
Infrastructure
Natural resources
Commodities
Less
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Neutral
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Investment preference
Alternatives
Our fixed income positioning remains at overweight, with bonds likely providing more stability during the coming economic slowdown. Within the U.S., we keep our overweight exposure to U.S. Treasurys, mortgages, and investment grade, recognizing that these fixed income assets' longer-duration, high-quality profile should outperform as the economy slows.
We move high yield to neutral, acknowledging that while spreads will likely widen as the economy slows, elevated yields may provide a decent cushion if spreads unwind. In addition, high yield credit quality is well above its historical average. Local currency emerging market debt moves to overweight as high real yields, central bank rate cuts, and likely further dollar weakness should combine to enhance returns.
Investment viewpoints
• IG credit heavy core fixed income for stability
• Agency MBS strategies
How to implement
Emerging market hard currency
Emerging market local currency
Developed market credit
Developed market sovereigns
Ex-U.S.
TIPS
Preferreds (debt & equity)
High yield/Senior loans
Investment grade corporates
Mortgages
Treasurys
U.S.
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Neutral
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Investment preference
Fixed Income
In recognition of the economic risks, our equities positioning remains at underweight. We prefer other markets over the U.S. Still, the shallow nature of the expected U.S. recession means that a significant and sustained pullback is unlikely, and investors should look for the opportunity to increase exposure once there has been some correction in current valuations. Within the U.S., large-cap equities should continue to benefit from both cyclical and secular fundamental tailwinds, although there is a risk of some pullback if elevated earnings expectations for tech firms prove overly optimistic.
Within developed markets ex-U.S., we increase our exposure to Japan due to the economic revival and likely shift in central bank policy. Within emerging markets, China’s recovery has proved disappointing, but there are substantial opportunities in other regions.
Investment viewpoints
• Large-cap U.S. strategies
• Quality-biased active managers
• Well-diversified and active international managers
How to implement
Emerging Markets
Developed Asia Pacific ex-Japan
Japan
UK
Europe
Ex-U.S.
Small-cap
Mid-cap
Large-cap
U.S.
Less
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Neutral
»
More
Investment preference
Equities
Alternatives
Fixed income
Equities
Less
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Neutral
»
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Investment preference
Diversified asset allocation: Underweight equities, overweight bonds and neutral alternatives.
indicates a change in preference from the previous quarter (light blue) to the current quarter (darker blue).
Viewpoints reflect a 12-month horizon
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 June 30, 2023.
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Investment implications
Equities
Index descriptions
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Important information
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.
MOVE index, or Merrill Lynch Option Volatility Estimate Index, is a crucial gauge of interest rate volatility in the U.S. Treasury market. The index measures the implied volatility of U.S. Treasury options across various maturities.
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.
VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options.
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 Spot Index measures the price movements of commodities included in the Bloomberg CI and select subindexes. It does not account for the effects of rolling futures contracts or the costs associated with holding physical commodities and is quoted in USD.
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. 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 Barclays 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.
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. 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 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).
Index descriptions
Todd Jablonski, CFA
Garrett Roche, CFA, FRM
Brian Skocypec, CIMA
Seema Shah
Han Peng, CFA
Ben Brandsgard
Principal Global Insights Team
Recorded April 18, 2023
What should investors expect from markets and the economy in the third 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.
3Q GAAV video presentation
Watch webcast
Download (PDF)
Insights team
Disclosures
Investment implications
Alternatives
Fixed income
Equities
Macro
Key themes
Global Asset Allocation Viewpoints
View video
Download (PDF)
Insights team
Disclosures
Investment implications
Alternatives
Fixed income
Equities
Macro
Key themes
Global Asset Allocation Viewpoints
Macro
Click the cards below to learn about each macro investment theme
• With recession likely to be short and shallow, any market pullback will also likely be short and shallow.
• Defaults should not spike significantly, while earnings decline should neither be deep nor sustained. As a result, a return to September 2022 lows for the S&P 500 is unlikely and the window will be small for increasing exposure to U.S. equities at attractive valuations.
• Investors should remain nimble and ready to deploy available cash towards U.S. equities as the economy and earnings approach their troughs.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Rebased to 100 at January 1, 2020
S&P 500 price to earnings ratio
versus ISM Manufacturing Index
S&P 500 versus NASDAQ 100 performance
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
2004–present
• The S&P 500 entered a new bull market during 2Q, shrugging off concerns of recession and restrictive monetary policy. This has re-rated equities to higher valuation multiples, appearing stretched and unreflective of the potential earnings risks ahead.
• With the foundations of an economic slowdown gradually falling into place and further Fed tightening still to come, earnings headwinds are likely to intensify.
• Cost cutting has preserved margins so far but, as inflation slows nominal growth, revenues are also placed at risk. Stretched valuations imply that U.S. equities are particularly vulnerable to earnings disappointment.
S&P 500 versus NASDAQ 100 performance
S&P 500 price to earnings ratio
versus ISM Manufacturing Index
What should investors expect from markets and the economy in the third 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
3Q GAAV video presentation
Download (PDF)
View video
Inflation is decelerating but remains sticky and elevated, so inflation mitigation via infrastructure remains crucial for investors. By contrast, the slowing growth outlook will further depress commodities and natural resources.
Alternatives provide important diversification against traditional equities and fixed income.
06
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 a decent cushion as spreads widen.
High-quality fixed income offers stability and income in this unfolding economic backdrop.
05
Notably, as a U.S. recession will likely be short and shallow, any equity pullback will likely be short and shallow. The following recovery will likely be reasonably swift, requiring a nimble and active response from investors.
Equities will come under pressure as earnings weaken and further rate hikes test valuations.
04
Stubborn core inflation has led to a repricing of central bank rate hikes, with further hikes to come in most DM economies, including the Federal Reserve (Fed). Inflation caution also implies that rate cuts will not start in 2023.
Most central banks are not done with monetary tightening; rate cuts off the agenda in DM.
03
Headline inflation is falling rapidly, but core inflation is proving to be a worry in developed markets (DM). Slower economic growth will be required to reach global central bank inflation targets. By contrast, emerging market (EM) inflation has fallen below DM inflation.
Inflation is decelerating, but at a slow pace, and will end the year meaningfully above target.
02
While manufacturing has struggled, global growth has been supported by the services sector. Despite resilient U.S. growth, the foundations have been laid for a short and shallow recession later this year.
Europe is weakening, China is disappointing, and the U.S. is approaching recession.
01
Scroll to learn more about our key themes.
Key Themes
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.
Global Asset Allocation Viewpoints
Time is
running out
3Q 2023
GDP-weighted
real policy rates
Emerging market debt versus U.S. dollar
Source: JP Morgan, CME group, Principal Asset Management. Data as of June 30, 2023.
2018–present
• At the start of March, the European Central Bank (ECB) was expected to hike a further 100 bps through this year.
• By the end of the month, after recent bank failures sent the financial sector into disarray, markets were expecting no further rate hikes from the ECB.
• Both the timing and rate path is unclear from here. Not only is it difficult to estimate how much further banking stresses will extend, the extent of tightening in bank lending standards that will result from recent banking sector stress is also uncertain.
Emerging market debt versus U.S. dollar
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Policy rates minus CPI YoY, GDP weighted, 2007–present
GDP-weighted
real policy rates
Emerging market debt could escape mostly unscathed in a mild U.S. recession. Faster inflation normalization in EM is allowing their central banks to start shifting to rate cuts.
Key insight
EM debt: Improved outlook
but with lingering risks
Historical high
yield spreads
High yield quality composition
Source: BlackRock Aladdin, Principal Asset Management. Data as of June 30, 2023.
Bloomberg U.S. Corporate HY 2% Issuer Capped Index, 2015–present
"• At the start of March, the European Central Bank (ECB) was expected to hike a further 100 bps through this year.
• By the end of the month, after recent bank failures sent the financial sector into disarray, markets were expecting no further rate hikes from the ECB.
• Both the timing and rate path is unclear from here. Not only is it difficult to estimate how much further banking stresses will extend, the extent of tightening in bank lending standards that will result from recent banking sector stress is also uncertain."
High yield quality composition
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Axis crosses at June 2023 value, 2000–present
Historical high
yield spreads
China’s disappointing recovery means policymakers could roll out stimulus, but it may not be big enough to benefit wider EM. However, there are positives within EM ex-China.
Key insight
Central bank tightening: Not the end
of the road just yet
High yield minus investment grade spreads versus ISM Manufacturing PMI
High yield minus investment grade spreads versus Senior Officer Loan Survey
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
U.S. recessions are shaded, 2000–present
• Core goods inflation should decline as supply chains fully normalize, but is hitting some road bumps recently.
• Shelter inflation will slow, but this deceleration may take longer to materialize if the economy remains resilient.
• Core services ex-housing, which Fed Chair Jerome Powell has drawn clear attention to, is closely related to wage growth. Slower economic activity and a looser labor market will be necessary to fade these pressures.
High yield minus investment grade spreads versus Senior Officer Loan Survey
• Global inflation is moderating, but so far this deceleration has been largely driven by last year’s energy price spike unwind.
• Core inflation remains uncomfortably high and, in some economies, continues to rise.
• The broad inflation takeaway from 1Q is that global central banks have made less progress towards disinflation than they had hoped.
Source: Institute for Supply Management, Bloomberg, Principal Asset Management.
Data as of June 30, 2023.
U.S. recessions are shaded, 2000–present
High yield minus investment grade spreads versus ISM Manufacturing PMI
Higher-quality fixed income assets should outperform in economic downturns, benefitting from tighter spreads and longer duration.
Key insight
Navigate credit headwinds with high-quality assets
10-year Treasury and the
ISM Manufacturing Index
S&P 500 versus Bloomberg Treasury Index correlation
Note: Correlation is of 1-day returns, within a 120-day rolling window. Source: S&P Dow Jones, Federal Reserve, Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Rolling 120-day correlation, total return, 2018–present
• Recent turmoil in the banking sector suggests the labor market strength will prove short-lived.
• Small banks account for 30% of all loans in the U.S. economy. They will likely spend several quarters repairing their balance sheets, implying tighter lending standards for both firms and households.
• This will lead to greater job losses, fading wage growth, weaker consumer spending, and ultimately a higher likelihood of recession.
S&P 500 versus Bloomberg Treasury Index correlation
• Labor markets remain very strong, and the U.S. unemployment rate sits close to 50-year lows. With nearly two job vacancies per unemployed worker, employers report considerable difficulties in filling available positions, maintaining upward pressure on wage growth.
• Robust jobs and wage growth have been key tailwinds for consumers.
Source: Institute for Supply Management, Standard & Poor's, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Year-over-year change, 1991–present
10-year Treasury and the
ISM Manufacturing Index
As the economy slows, U.S. Treasurys will likely provide important security and diversification benefits, as well as capital appreciation.
Key insight
U.S. Treasurys: A sleeping
pill for investors
Yield comparison: S&P 500, investment grade bonds, and
3-month Treasury bills
Equity versus
bond volatility
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
2001–present
• Recent turmoil in the banking sector suggests the labor market strength will prove short-lived.
• Small banks account for 30% of all loans in the U.S. economy. They will likely spend several quarters repairing their balance sheets, implying tighter lending standards for both firms and households.
• This will lead to greater job losses, fading wage growth, weaker consumer spending, and ultimately a higher likelihood of recession.
Equity versus
bond volatility
• Labor markets remain very strong, and the U.S. unemployment rate sits close to 50-year lows. With nearly two job vacancies per unemployed worker, employers report considerable difficulties in filling available positions, maintaining upward pressure on wage growth.
• Robust jobs and wage growth have been key tailwinds for consumers.
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 June 30, 2023.
S&P 500 earnings yield, investment grade bond YTW, and 3-month Treasury bills yield
Yield comparison: S&P 500, investment grade bonds, and
3-month Treasury bills
Investors are getting higher compensation for taking interest rate risk than equity risk. With the economy set to slow, there’s strong rationale for locking-in more secure fixed income streams.
Key insight
Fixed income: Interest rate risk
is favorable to equity risk
Scroll to learn about each fixed income investment theme
Fixed Income
MSCI Europe and Germany industrial manufacturing orders
Cumulative foreign flows into Japan equities
Source: Japan Ministry of Finance, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Billions, 2012–present
"• At the start of March, the European Central Bank (ECB) was expected to hike a further 100 bps through this year.
• By the end of the month, after recent bank failures sent the financial sector into disarray, markets were expecting no further rate hikes from the ECB.
• Both the timing and rate path is unclear from here. Not only is it difficult to estimate how much further banking stresses will extend, the extent of tightening in bank lending standards that will result from recent banking sector stress is also uncertain."
Cumulative foreign flows into Japan equities
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: MSCI Inc., Deutsche Bundesbank, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Level, 2003–present
MSCI Europe and Germany industrial manufacturing orders
Japan is enjoying an economic revival. Healthier inflation prospects will likely trigger BoJ tightening, bolstering the yen and adding to returns for USD based investors.
Key insight
Europe’s and (especially)
Japan’s reversal in fortunes
People's Bank of China historical rate cuts
China imports
in 2022
Source: Bloomberg, Principal Asset Management. Data as of December 31, 2022.
Share of key import regions, calendar year 2022
"• At the start of March, the European Central Bank (ECB) was expected to hike a further 100 bps through this year.
• By the end of the month, after recent bank failures sent the financial sector into disarray, markets were expecting no further rate hikes from the ECB.
• Both the timing and rate path is unclear from here. Not only is it difficult to estimate how much further banking stresses will extend, the extent of tightening in bank lending standards that will result from recent banking sector stress is also uncertain."
China imports
in 2022
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: People’s Bank of China, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
September 2019–present
People's Bank of China historical rate cuts
China’s disappointing recovery means policymakers could roll out stimulus, but it may not be big enough to benefit wider EM. However, there are positives within EM ex-China.
Key insight
Central bank tightening: Not the end
of the road just yet
S&P 500 sector
YTD returns
Contribution to headline
U.S. Inflation
Source: S&P Dow Jones, Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
1995–present
• Core goods inflation should decline as supply chains fully normalize, but is hitting some road bumps recently.
• Shelter inflation will slow, but this deceleration may take longer to materialize if the economy remains resilient.
• Core services ex-housing, which Fed Chair Jerome Powell has drawn clear attention to, is closely related to wage growth. Slower economic activity and a looser labor market will be necessary to fade these pressures.
Contribution to headline U.S. inflation
• Global inflation is moderating, but so far this deceleration has been largely driven by last year’s energy price spike unwind.
• Core inflation remains uncomfortably high and, in some economies, continues to rise.
• The broad inflation takeaway from 1Q is that global central banks have made less progress towards disinflation than they had hoped.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Total return, January 2023–present
S&P 500 sector
YTD returns
The narrowness of the U.S. rally means that diversification via non-U.S. equities, which have lower tech concentration and less correlated to the AI excitement, may be warranted.
Key insight
Bad breadth and narrow market leadership
S&P 500 price to earnings ratio versus ISM Manufacturing Index
S&P 500 versus NASDAQ
100 performance
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Rebased to 100 at January 1, 2020
• Recent turmoil in the banking sector suggests the labor market strength will prove short-lived.
• Small banks account for 30% of all loans in the U.S. economy. They will likely spend several quarters repairing their balance sheets, implying tighter lending standards for both firms and households.
• This will lead to greater job losses, fading wage growth, weaker consumer spending, and ultimately a higher likelihood of recession.
S&P 500 versus NASDAQ
100 performance
• Labor markets remain very strong, and the U.S. unemployment rate sits close to 50-year lows. With nearly two job vacancies per unemployed worker, employers report considerable difficulties in filling available positions, maintaining upward pressure on wage growth.
• Robust jobs and wage growth have been key tailwinds for consumers.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
2004–present
S&P 500 price to earnings ratio versus ISM Manufacturing Index
While U.S. equities are vulnerable to earnings disappointment, the short and shallow nature of recession implies any pullback will be equally short and shallow.
Key insight
U.S. equities defy rate hikes
and recession concerns
• The broad equity market performance in 1Q was fairly resilient, shrugging off concerns around banking sector stress and elevated recession risk.
• Following the quarter rally, global equity valuations have become less attractive, although most markets can still be considered relatively cheap following last year’s drawdown.
• In Europe, Germany and the UK remain attractive, while valuations in the European banking sector have only been cheaper during the GFC and the European Sovereign Debt crisis.
• Emerging markets can also be considered cheap, driven by significantly discounted valuations in Latin America.
Source: FactSet, Bloomberg, MSCI, Principal Asset Allocation. LTM (last twelve months) returns are total return and in USD terms. % Time Cheaper is relative to PAA Equity Composite Valuation history. PAA Equity Composite Valuation is a calculated measure, comprised of 60% price-to-earnings, 20% price-to-book and 20% to dividend yield. Composite started in 2003. EAFE is Europe, Australasia, Far East. See disclosures for index descriptions. Data as of June 30, 2023.
Last twelve months returns and % times cheaper, MSCI indices
Global equity returns and valuations
After 2Q’s rally, global equity valuations have become more stretched. The U.S. remains the most expensive market, while Latin America has rarely been cheaper.
Key insight
Global equity valuations are
becoming more stretched
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Equities
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Principal Asset Allocation Financial Conditions Index (FCI), Z-score, 2005–present
Developed market and emerging market financial conditions
Now that risks have swung towards higher terminal rates, market sentiment is beginning to look vulnerable and financial conditions are overdue a tightening trend.
Key insight
Financial conditions are
overdue a reversal
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: Bureau of Labor Statistics, Bloomberg, Principal Asset Management. Data as of July 12, 2023.
Consumer Price Index (CPI)
Historical inflation comparison
The risks associated with premature rate cuts are significant. The Fed would need to see a desperately struggling economy or a financial crisis to justify rate cuts this year.
Key insight
Lessons from the 70s:
No space for rate cuts in 2023
Federal Reserve rates path
European Central Bank rates path
Source: Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Future market priced ECB rates path as of March 31 vs. June 30
"• At the start of March, the European Central Bank (ECB) was expected to hike a further 100 bps through this year.
• By the end of the month, after recent bank failures sent the financial sector into disarray, markets were expecting no further rate hikes from the ECB.
• Both the timing and rate path is unclear from here. Not only is it difficult to estimate how much further banking stresses will extend, the extent of tightening in bank lending standards that will result from recent banking sector stress is also uncertain."
Europe Central Banks rates path
• Market expectations for Fed funds rates in early March were edging towards a 6% terminal rate for the Fed and no rate cuts through 2023.
• However, recent bank failures shave emphasized the need for central banks to put extra focus on financial stability, and markets now expect no further Fed hikes, plus three rate cuts this year.
• Our own Fed forecasts see a peak rate of 5.25%- 5.50% as the central bank continues to use its policy rate to target inflation, while using its balance sheet liquidity to target financial stability.
Source: Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
Future market priced fed funds rates path as of March 31 vs. June 30
Federal Reserve rates path
Inflation persistence mean that markets need to raise their developed market rate expectations, and also price out any rate cuts this year.
Key insight
Central bank tightening: Not the end
of the road just yet
Principal Asset Allocation
GDP-weightted inflation
Contribution to headline
U.S. Inflation
Source: Bureau of Labor Statistics, Principal Asset Management. Data as of July 12, 2023.
Year-over-year, 2015–present
• Core goods inflation should decline as supply chains fully normalize, but is hitting some road bumps recently.
• Shelter inflation will slow, but this deceleration may take longer to materialize if the economy remains resilient.
• Core services ex-housing, which Fed Chair Jerome Powell has drawn clear attention to, is closely related to wage growth. Slower economic activity and a looser labor market will be necessary to fade these pressures.
Contribution to headline U.S. inflation
• Global inflation is moderating, but so far this deceleration has been largely driven by last year’s energy price spike unwind.
• Core inflation remains uncomfortably high and, in some economies, continues to rise.
• The broad inflation takeaway from 1Q is that global central banks have made less progress towards disinflation than they had hoped.
Source: Bloomberg, Principal Asset Allocation. Data as of July 12, 2023.
January 2007–February 2023
Principal Asset Allocation
GDP-weighted inflation
DM central banks have made less progress towards disinflation than they had hoped. Inflation is likely to remain sticky and will still sit above global central bank targets at year-end.
Key insight
Global disinflation dispersion
Aggregate excess savings following recession
Small business credit conditions and initial jobless claims
Source: NFIB, Bureau of Labor Statistics, Bloomberg, Principal Asset Management. Data as of July 11, 2023.
1986–present
• Recent turmoil in the banking sector suggests the labor market strength will prove short-lived.
• Small banks account for 30% of all loans in the U.S. economy. They will likely spend several quarters repairing their balance sheets, implying tighter lending standards for both firms and households.
• This will lead to greater job losses, fading wage growth, weaker consumer spending, and ultimately a higher likelihood of recession.
Small business credit conditions and initial jobless claims
• Labor markets remain very strong, and the U.S. unemployment rate sits close to 50-year lows. With nearly two job vacancies per unemployed worker, employers report considerable difficulties in filling available positions, maintaining upward pressure on wage growth.
• Robust jobs and wage growth have been key tailwinds for consumers.
Source: Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Trillions, months since start of recession
Aggregate excess savings following recession
Deterioration in both consumer spending and labor market activity will likely precipitate the arrival of one of the most anticipated recessions in history.
Key insight
Recession: Stop me if you’ve
heard this one before...
Developed market and China Purchasing Managers’ Index (PMI)
U.S. recession probability in next 12 months
Source: Federal Reserve Bank of New York, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Federal Reserve Bank of New York, 1960–present
• Even as the global economy looks strong, leading indicators emphatically signal recession.
• The New York Fed’s own recession model suggests that the probability of recession within the next 12 months is the highest since the early 1980s.
U.S. recession probability in next 12 months
• Global economic activity has continued to defy policy tightening and the multiple geopolitical shocks.
• Softness in economic data in late-2022 proved to be seasonal noise and, in fact, since the start of 2023, activity data has only emphasized the continued resilience of the global economy.
• The stabilization in global manufacturing activity can be at least partially traced back to the reopening bounce in China, while the sharp drop in energy prices has given global consumers a boost.
Source: Bloomberg, Principal Asset Allocation. Data as of May 31, 2023.
May 2008–present
Developed market and China Purchasing Managers’ Index (PMI)
With three largest economies facing varying levels of slowdown, the global growth outlook has deteriorated.
Key insight
Global economy: Shades of grey
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Macro
Index descriptions
Important information
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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
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.
MOVE index, or Merrill Lynch Option Volatility Estimate Index, is a crucial gauge of interest rate volatility in the U.S. Treasury market. The index measures the implied volatility of U.S. Treasury options across various maturities.
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.
VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options.
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 Spot Index measures the price movements of commodities included in the Bloomberg CI and select subindexes. It does not account for the effects of rolling futures contracts or the costs associated with holding physical commodities and is quoted in USD.
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. 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 Barclays 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.
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. 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 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).
Index descriptions
Equities
Fixed Income
Alternatives
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 June 30, 2023.
indicates a change in preference from the previous quarter (light blue) to the current quarter (darker blue).
Viewpoints reflect a 12-month horizon
• Diversified real asset strategies (infrastructure, natural resources)
• Private real estate markets
How to implement
Alternatives shift to neutral as, although they provide important diversification benefits, the outlook for specific segments has deteriorated. We shift our commodities and natural resources positions to underweight, concerned by the coming global growth slowdown and likely equity market downturn. REITs remain at underweight, given continued pressures on the real estate sector, particularly from the office space. We shift hedge funds to neutral as volatility remains very subdued. By contrast, we maintain our overweight to infrastructure, encouraged by its inflation-protection characteristics, stability of cash flows, and exposure to the structural de-carbonization trend.
Investment viewpoints
Hedge funds
REITs
Infrastructure
Natural resources
Commodities
Less
«
Neutral
»
More
Investment preference
Alternatives
• IG credit heavy core fixed income for stability
• Agency MBS strategies
How to implement
Our fixed income positioning remains at overweight, with bonds likely providing more stability during the coming economic slowdown. Within the U.S., we keep our overweight exposure to U.S. Treasurys, mortgages, and investment grade, recognizing that these fixed income assets' longer-duration, high-quality profile should outperform as the economy slows. We move high yield to neutral, acknowledging that while spreads will likely widen as the economy slows, elevated yields may provide a decent cushion if spreads unwind. In addition, high yield credit quality is well above its historical average. Local currency emerging market debt moves to overweight as high real yields, central bank rate cuts, and likely further dollar weakness should combine to enhance returns.
Investment viewpoints
Emerging market hard currency
Emerging market local currency
Developed market credit
Developed market sovereigns
Ex-U.S.
TIPS
Preferreds (debt & equity)
High yields/Senior loans
Investment grade corporates
Mortgages
Treasurys
U.S.
Less
«
Neutral
»
More
Investment preference
Fixed Income
• Large-cap U.S. strategies
• Quality-biased active managers
• Well-diversified and active international managers
How to implement
In recognition of the economic risks, our equities positioning remains at underweight. We prefer other markets over the U.S. Still, the shallow nature of the expected U.S. recession means that a significant and sustained pullback is unlikely, and investors should look for the opportunity to increase exposure once there has been some correction in current valuations. Within the U.S., large-cap equities should continue to benefit from both cyclical and secular fundamental tailwinds, although there is a risk of some pullback if elevated earnings expectations for tech firms prove overly optimistic. Within developed markets ex-U.S., we increase our exposure to Japan due to the economic revival and likely shift in central bank policy. Within emerging markets, China’s recovery has proved disappointing, but there are substantial opportunities in other regions.
Investment viewpoints
Emerging Markets
Developed Asia Pacific ex-Japan
Japan
UK
Europe
Ex-U.S.
Small-cap
Mid-cap
Large-cap
U.S.
Less
«
Neutral
»
More
Investment preference
Equities
Alternatives
Fixed income
Equities
Less
«
Neutral
»
More
Investment preference
Diversified asset allocation: Underweight equities, overweight bonds and alternatives.
Click each tab to learn more about the investment implications
Investment implications
• Global inflation is moderating, but so far this deceleration has been largely driven by last year’s energy price spike unwind.
• Core inflation remains uncomfortably high and, in some economies, continues to rise.
• The broad inflation takeaway from 1Q is that global central banks have made less progress towards disinflation than they had hoped.
Note: Data since 4Q 2013 is average of construction and land development, nonfarm nonresidential and multifamily. Source: Federal Reserve, Principal Asset Management. Data as of June 30, 2023.
Senior Loan Officer Opinion Survey on Bank Lending Practices, 1991–present
U.S. bank responses regarding
commercial real estate loans
REITs are due for a further pullback. Yet, once valuations have reset, deteriorating economic fundamentals may signal a more positive story for REITs.
Key insight
REITs vulnerable to recent banking sector strains
• Labor markets remain very strong, and the U.S. unemployment rate sits close to 50-year lows. With nearly two job vacancies per unemployed worker, employers report considerable difficulties in filling available positions, maintaining upward pressure on wage growth.
• Robust jobs and wage growth have been key tailwinds for consumers.
Note: Global equities is represented by MSCI All Country World Index. Global listed Infrastructure is represented by the MSCI ACWI Utilities Index from 2003 through 2006, a 50/50 blend of MSCI ACWI Utilities Index and the Alerian MLP Index from 2007 through 2015, and the FTSE Global Core Infrastructure 50/50 Index thereafter. Past performance does not guarantee future results. Index performance information reflects no deduction for fees, expenses, or taxes. Indices are unmanaged and individuals cannot invest directly in an index. Source: U.S. Bureau of Labor Statistics, CPI ex-food & energy, FactSet, Principal Asset Management. Data as of December 31, 2022.
2003–present
Listed infrastructure versus global
equities in years of higher inflation
Infrastructure continues to offer important inflation mitigation and a more stable income stream.
Key insight
Infrastructure’s crucial
defensive role in portfolios
Bloomberg Commodities Index and South Korean trade exports in U.S. dollars
S&P Energy Capital
Expenditure
Source: S&P Dow Jones, Macroeconomic Advisers, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
Adjusted for U.S. nominal GDP, 1993–present
• Recent turmoil in the banking sector suggests the labor market strength will prove short-lived.
• Small banks account for 30% of all loans in the U.S. economy. They will likely spend several quarters repairing their balance sheets, implying tighter lending standards for both firms and households.
• This will lead to greater job losses, fading wage growth, weaker consumer spending, and ultimately a higher likelihood of recession.
S&P Energy Capital
Expenditure
• Labor markets remain very strong, and the U.S. unemployment rate sits close to 50-year lows. With nearly two job vacancies per unemployed worker, employers report considerable difficulties in filling available positions, maintaining upward pressure on wage growth.
• Robust jobs and wage growth have been key tailwinds for consumers.
Source: Korean Ministry of Trade, Industry and Energy, Bloomberg, Principal Asset Allocation. Data as of June 30, 2023.
2002–present
Bloomberg Commodities Index and South Korean trade exports in U.S. dollars
The short-term commodity outlook is fairly weak as China growth concerns add to U.S. growth fears. By contrast, long-term trends are clearer and more constructive.
Key insight
Commodities: Short-term
pain but long-term gain
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Alternatives
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