Asset Allocation Views
Please refer to important disclosures at the end of this report.
Consumers were spending their tax rebates right on schedule, raising retail
sales in May. Higher gasoline prices, however, now threaten to cancel out
the stimulus provided by the rebates. GDP growth is likely to decelerate in
2H as the stimulus from the rebates wears off and higher energy costs
dampen consumer spending.
Bond and futures markets priced in a series of future rate hikes after Fed
Chairman Ben Bernanke warned about inflation in a speech in early June.
Fed officials have since signaled that they believe the markets have priced in
too much tightening too soon.
Before tightening, the Fed will want to wait until it can determine whether the
boost to the economy from the fiscal stimulus package and past monetary
easing will last into the third and fourth quarters of this year, and how much
damage $141 per barrel oil has done to the economy, in our view.
Commodity prices and weakness in the dollar are putting upward pressure
on headline consumer price inflation. There is no evidence yet, however, that
a wage-price spiral is developing that would raise core inflation.
After rising over 12% from its low in early March, when concerns about a
recession and financial system instability were at the fore, sentiment has
taken a turn for the worse in the U.S. stock market. It will likely take lower oil
prices and a rebound in growth for the market to rally from current levels.
On July 1 we moved back to neutral in U.S. large-cap, mid-cap, and small-
cap stocks and raised our allocation to bonds to neutral. With the market
being driven by oil prices, overweight equity positions are vulnerable to a rise
in oil prices, and underweight positions risk missing any gains that occur if oil
GDP growth in the eurozone, the U.K. and Japan is decelerating. The ECB,
meanwhile, has signaled that it is inclined toward a one-off raise in policy
rates in July to dampen inflation expectations. With