Asian investors: Master the multi-asset approach amid a shifting market landscape

The global economy is changing gear as it adjusts to a slower rate of growth, but that doesn’t mean investors should be pessimistic. While a hard landing can’t be ruled out, the prospects for a soft landing appear far more probable. The Federal Reserve kicked off the shift towards a new global easing landscape in September 2024 with its 50-basis-points cut in interest rates, followed by a 25bp cut in November. Further monetary policy easing is anticipated 2025. With many other global central banks following suit, risk assets such as equities are expected to benefit.

The shift toward easing monetary policy reflects that inflationary pressures have eased, and the Fed is now shifting its focus to the health of the labor market. While investors would love to say that inflation has subsided appropriately, we believe it is too early to claim that a return to a stable 2% inflation rate is assured. A deviation from current disinflation trends could pose challenges to the Fed’s ability to ease further. In this evolving market context, diversification will prove essential in allowing investors to navigate the complexities ahead.

Multi-asset investing: invest for growth, while staying alert to the risks

We believe the market cycle is composed of four distinct stages: recovery, expansion, contraction, and decline. Currently, the global economy is experiencing a prolonged, three-year period of economic decline. Such declines have historically led to one of two potential resultant outcomes: expansion or contraction, and it’s the latter that often results in negative returns for risk assets. Will the current decline result in a painful contraction and negative returns for stocks, or are we headed for a soft landing with a swift rebound to follow? Looking through the short-term noise, we believe a soft landing and modest expansion support the case for a slight equity overweight.

Figure 1: Principal Asset Allocation regime indicator

Z-score, 2002–present

Source: Bloomberg, Principal Asset Allocation. Data as of September 30, 2024.

In the words of Harry Markowitz, the Nobel prize-winning economist best known for his pioneering work in modern portfolio theory, “the only free lunch in investing is diversification.” Adopting a multi-asset investment strategy allows investors to diversify across uncorrelated asset classes, and position portfolios to weather potential market storms while remaining poised to seize opportunities as risk appetite returns. This approach transcends the simplistic binary approach of preparing for either contraction or expansion, better equipping investors to increase the probability that they can reach their goals despite an ever complex and evolving macro-economic outlook.

A world of investment opportunities

The Fed’s easing cycle should support equities, presenting opportunities in the U.S. across all market capitalization categories. While large cap U.S. equities have generated the lion’s share of market returns of late, we have shifted to a more neutral stance on U.S. equities in anticipation of the global growth outlook starting to slow. US mid- and small-caps could be better positioned going forward than they were in the era of low rates and low tariffs.

Outside the US, most regional valuations are high and global markets have collectively performed well. The most attractive valuations to date are in Latin America and Hong Kong. Japan also stands out, where equities are benefiting from shareholder returns through dividends and/or share buybacks. Europe, conversely, continues to search for an economic acceleration and we remain underweight developed European equities.

A diversified basket of emerging-market equities aims to provide portfolio diversification across regions which may ultimately translate to improved risk-adjusted returns. We are neutral across the emerging market equity complex, but we do see opportunity in select countries. Notably, Indian and Taiwanese equity markets have attractive growth characteristics. China’s policy pivot has led to a quick market recovery, yet we need to see material fiscal stimulus action before our outlook changes on the region.

The role of fixed income

Historically, bonds have typically brought stability to a portfolio. Bonds typically have a lower standard deviation than equities. Of late however, bond volatility has indeed been below that of equities… but bond volatility has been higher than what’s typical for a stability asset class. What is causing the current bond volatility? It’s interest rate volatility. Rate volatility has picked up as investors are striving to anticipate the speed and degree to which central banks will ease monetary policy. Any separation between investor expectation and central bank action results in excess volatility.

Historically, bonds have typically brought stability to a portfolio. Bonds typically have a lower standard deviation than equities. Of late however, bond volatility has indeed been below that of equities… but bond volatility has been higher than what’s typical for a stability asset class. What is causing the current bond volatility? It’s interest rate volatility. Rate volatility has picked up as investors are striving to anticipate the speed and degree to which central banks will ease monetary policy. Any separation between investor expectation and central bank action results in excess volatility.

We anticipate as the easing cycle ensues that the yield curve should start to steepen as the long end of the curve is expected to drift higher. However, as the easing cycle becomes established, yield curves are expected to be more stable and provide an opportunity as a hedge for growth risks.

On the short end of the yield curve, we favor high-quality credit and carry, and we have been underweight to the lower quality credit part of the curve.

At the same time, we also find opportunities on the long end of the curve to help manage growth risks. A position in 30-year US Treasuries allows us to keep a defensive strategy at the ready. They offer attractive yields and should provide a safe haven should markets experience any unexpected shocks, such as geopolitical developments. Economic news may also trigger volatility, although we expect this to stem from growth rather than inflation shocks.

Space for Alternatives in a Balanced Portfolio: A Case for Gold

We are generally underweight commodities; however, we do see opportunity in gold. Gold price action is a function of supply and demand, and rising demand should lead to higher prices; thus, we are optimistic on gold in a multi-asset portfolio. China and India, which account for 35% of the world’s population, are generating a steadily increasing demand for gold.¹ India has also reduced its gold import duties from 15% to 6%, a move that should continue to fuel demand.² Moreover, central banks are buying for diversification purposes, including a move away from the dollar.

Why a multi-asset approach could be the answer in an uncertain world

In a world subject to a multitude of geopolitical and economic risks, a multi-asset approach clearly should have a strong appeal to investors. It offers the largest opportunity set of investment choices. Moreover, by exploiting the varying returns from different asset classes and sectors, investors can offset risk and achieve smoother returns in a way that is not possible when investing in either single markets or single asset classes. Given that volatility could be spiking again, as shown in Figure 2, that is clearly an important consideration in today’s environment.

Figure 2: Volatility on an upward trend

PAA Cross-Asset Volatility Index
Weighted market implied volatilities of equities, bonds, currency and crude oil

Source: Bloomberg, Principal Asset Allocation. Data as of September 30, 2024.

In conclusion, mixing different asset classes with lower standard deviations and potentially inverse correlations creates the ability to generate risk-adjusted returns. Diversification thereby offers the potential to smooth portfolio returns and provide better protection during drawdown periods.