Over the past month, global economic activity has continued to decelerate, confirming the slowing momentum we highlighted a few weeks ago. This deceleration has been fairly broad-based across regions and sectors, with business surveys in both manufacturing and services reflecting a reversal in nearly all of the improvements seen in the fourth quarter of last year.

Overall, we believe the global economy has entered a “slowdown” regime, characterized by above-trend growth rates, but still decelerating. The growth trend has moderated most notably in Europe, followed by Asia, while we continue to see a moderate rate of acceleration in the United States, which remains in an expansionary regime (Exhibit 1).

Global financial markets have taken notice. Our global market sentiment indicators are signaling a decline in global risk appetite, as riskier asset classes have, on average, underperformed safer assets (Exhibit 2). Similarly, equity markets volatility has begun to incorporate some of the uncertainty in the growth outlook, coupled with ongoing noise surrounding NAFTA negotiations and the rising tensions between China and the U.S. on trade tariffs and disputes.

Despite the rhetoric, at this stage we remain constructive on the resolution of these disputes, as all parties involved have expressed willingness to reach successful negotiations via some form of compromise. However, in our previous update, we highlighted how trade tensions and loss of economic momentum represented some of the main risks to our asset allocation views, which are broadly tilted towards risky assets. Historically, a macro backdrop like the current one has typically delivered moderate positive returns for risk assets, but little compensation in terms of premium over safer assets, especially on a risk-adjusted basis. As a result, over the past month, we have brought our overall equity exposure from overweight back to neutral as we wait for stabilization in economic growth, which we expect will go through a “soft patch” in the next few months. In terms of regional exposures, we continue to be overweight emerging markets versus developed markets across equities, fixed income and currencies. While we do not expect a disruptive rise in interest rates, we maintain a moderate underweight in duration both in the United States and developed markets. We expect U.S. inflation to gradually rise toward 2%, and the U.S. Federal Reserve (Fed) to continue on its gradual tightening path. We maintain a slight overweight in Brent oil, which we believe is fundamentally supported by above-trend global growth and falling inventories.

Finally, one of the main portfolio changes enacted this month pertains to the increase in our exposure to event-linked bonds.  Multiple hurricanes and wildfires in the second half of 2017 caused significant insurance losses and tested the absorption capacity of property-reinsurance markets.  These developments, in turn, have caused event-linked-bond spreads to increase from a low of about 4% to approximately 9.3%,1 with only a modest uptick in forward-looking expected losses.

In addition to attractive yield and total return prospects, we believe that event-linked bonds offer compelling diversification characteristics, as natural catastrophes have generally exhibited low correlation with shocks to economic growth.  Moreover, we see floating-rate event-linked bonds as particularly attractive securities versus more traditional high-yielding asset classes given the advanced state of the credit cycle and the marginal loss of growth momentum we cite above.

  1. ^Source: Swiss Re Capital Markets, as of 3/31/18.