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Asset Allocation Viewpoints – Q3 2021

Actionable investment conclusions from Harbor’s Multi-Asset Solutions Team

October 08, 2021
Hiker on steep roof ladder connected to the top of a rocky cliff
Hiker on steep roof ladder connected to the top of a rocky cliff

Macro Landscape

Growth Reacceleration Into Q4?

  • Our July monthly update was titled “As The Data Changes, You Change” for a reason; our growth cycle regime models transitioned to “Deceleration” early in Q2, elevated inflation has pulled forward the Fed’s dot plot, rising Delta cases have led to downward growth revisions in Q3 and Q4, and our models identified a significant growth slow down in China starting in Q1
  • What has changed since? We are still in a “Deceleration” growth phase more broadly, but we now see a brief period of respite as growth reaccelerates into Q4 due to the waning of global and U.S. Delta case counts; moreover, Powell sufficiently calmed markets with his address at Jackson Hole reassuring that the Fed would not raise rates prematurely due to elevated levels of inflation in 2021 and 2022
  • Global supply chain issues are unlikely to ebb until 2H 2022 or possibly 2023; we therefore expect inflation to remain above 2.0% for the foreseeable future
  • We believe consumer expectations for elevated albeit transitory inflation are preventing excess savings from being deployed into the real economy; as inflation decelerates into 2022, we think at least some of the excess savings glut will be spent
  • The Delta variant is unlikely to cause an alarming rise in hospitalizations or deaths in the developed world, but we do see cases ultimately rising in the U.S. and Europe nonetheless; we see the U.S. as more insulated due to a higher proportion of the population receiving two vaccine doses
  • We are monitoring the following downside scenarios closely: 1) Persistent rather than transitory inflation; 2) Geopolitical risks with China as the Biden administration has proved more hawkish than expected; 3) Delta variant; 4) Rising corporate tax rates and regulation; 5) Overly hawkish Fed; 6) Slowdown in China and the highly leveraged property sector

Tactical Asset Allocation & Market Themes


Equity Markets

· We remain overweight equities as our longer term business cycle regime model points to a “Low Risk Expansion” in the developed world (U.S., Europe and Japan) given high levels of growth activity. Our shorter term growth cycle model points to a “Deceleration” regime in the developed world as the rate of growth slows from peak levels. Delta variant cases are now declining globally and should drive a reacceleration of growth momentum in Q4 before decelerating again next year. Equities tend to generate above average returns in the “Low Risk Expansion” regime of the business cycle, and U.S. equities tend to outperform during the “Deceleration” growth cycle (although we think real GDP is likely to accelerate in Q4, our models still point to a current regime of ‘Deceleration’).

· We maintain a neutral position to Europe, which has a relatively more attractive rate of change in economic data vs our other regional models. We are underweight China/emerging markets (EM) given that China shifted into a “Contraction” business cycle regime in July and is in a growth cycle “Slowdown” regime.

· Our equity risk premia model continues to forecast high single digit returns over the next 12 months given strong earnings growth and fairly stable multiples as we model the 10-year UST to reach 1.55% in 12 months.

Fixed Income

· We retain our underweight position to duration as we expect the 10 year to rise to 1.60% by the end of 2022 and view current yield levels as unattractive; however, we temper our underweight given the diversification benefits of duration in our portfolio and maintain a slight overweight to investment grade credit as a result. We do not feel compelled to have too much duration as a hedge at the present time given that equity drawdowns are less frequent in a “Low Risk Expansion” business cycle regime.

Credit Markets

· We maintain our small underweight to credit and U.S. high yield as we do not view further spread tightening as likely from here. We think carry remains the primary source of return for the asset class with U.S. high yield priced to deliver low single digit returns above duration matched treasuries. While we prefer credit to duration, we have a stronger preference for cyclical risk in equities relative to credit.

Asset Allocation Views, In Summary…



Source: MAST, Bloomberg L.P.; data as of September 2021



Source: MAST, Bloomberg L.P.; data as of September 2021; expectations aggregated from the following 12 firms: Bank of America, J.P. Morgan, Morgan Stanley, UBS, Goldman, Barclays, Deutsche Bank, Jefferies, RBC, Citi, Credit Suisse, Wells Fargo



Source: MAST, Bloomberg L.P.; data as of July 2021

What Keeps Us Up at Night…

  • Rising Corporate Taxes and Regulation

    Democrats have signaled a desire to raise corporate, personal and dividend/capital gains tax rates; there has even been discussion of implementing a new wealth tax. These actions would be fiscally restrictive, all else equal, and a higher corporate tax rate would affect the value ascribed to U.S. equities.

  • COVID-19 Variants

    As different COVID mutations evolve and form into variant strains of the virus, there is a risk that mortality rises, vaccines become less efficacious, and societies shut down again as new booster shots are formulated to address the new variants. We are currently seeing elevated risk here with the COVID Delta Variant. This risk is more pronounced in Emerging Markets where vaccinations are less prevalent, but also Europe where single dose injections have been more common than two dose injections. Single dose injections have been shown to be less effective at preventing symptomatic infection, although still effective at preventing severe outcomes (hospitalizations/mortality).

  • Vaccine Adoption and Success

    The majority of adults in the U.S. and in Europe have now been vaccinated. There is a risk, however, that a sufficiently large part of the population chooses to avoid vaccinations and therefore prevent societies from reaching herd immunity. This is also a risk in Emerging Markets where vaccination rates are far behind the U.S., UK and Europe.

  • Inflation and Rising Rates

    With strong above trend growth already in the works for 2021 along with massive fiscal stimulus, it is possible that inflation rises faster and remains more persistent than the market currently expects. This could cause the Fed to act sooner rather than later, both in terms of pulling back on QE but also in terms of signaling a higher Fed Funds rate through the dot plot trajectory. Additionally, high levels of inflation that is expected to be transitory can discourage consumption.

  • Fed Mistake

    If the Fed chooses to pull back on stimulus too quickly - or send a signal that it’s stimulus and dovish posture may last shorter than the market expects - it could lead to volatility in rates markets that may then spill over into other asset classes.

  • Regulatory Risk with Big Tech

    The Justice Department has ramped up its Google probe; given the size of Big Tech and their concentration in passive indices, this could have a significant impact on markets.

  • Economic Slowdown in China

    Growth has weakened considerably in China as a result of tightening monetary conditions, rolling lockdowns from COVID and capital flight due to Beijing’s regulatory crackdown. We are seeing the effects of this slowdown and regulatory crackdown most acutely in the overleveraged property sector with a likely bankruptcy of Evergrande.

Legal Notices & Disclosures

The views expressed herein are those of the Harbor Multi Asset Solutions Team at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. These views are not necessarily those of the Harbor Investment Team and should not be construed as such. The information provided is for informational purposes only.

Past performance is no guarantee of future results.

All charts and tables are shown for illustrative purposes only; positioning as of September 2021​

The information shown relates to the past. Past performance is not a guide to the future.

All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Bonds may decline in response to rising interest rates, a credit rating downgrade or failure of the issue to make timely payments of interest or principal. International investments can be riskier than U.S. investments due to the adverse affects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. ​

Fixed income securities fluctuate in price in response to various factors, including changes in interest rates, changes in market conditions and issuer-specific events, and the value of an investment may go down. This means potential to lose money.​

As interest rates rise, the values of fixed income securities are likely to decrease and reduce the value of a portfolio. Securities with longer durations tend to be more sensitive to changes in interest rates and are usually more volatile than securities with shorter durations. Interest rates in the U.S. are near historic lows, which may increase exposure to risks associated with rising rates. Additionally, rising interest rates may lead to increased redemptions, increased volatility and decreased liquidity in the fixed income markets.​

Harbor MAST BCI Index Sources: Harbor MAST, Bloomberg, Institute of Supply Management, Federal Reserve, Bureau of Labor Statistics, Commodity Research Bureau, National Federation of Independent Business (NFIB), Caixin, European Commission, Japan Machine Tool Builder’s Association, Association of American Railroads, American Iron and Steel Institute, Department of Labor, Conference Board, University of Michigan, Redbook Research, National Association of Homebuilders, Mortgage Bankers Association​.

Harbor MAST BCI and Rate of Change Index Sources: Harbor MAST, Bloomberg, Institute of Supply Management, Federal Reserve, Bureau of Labor Statistics, Commodity Research Bureau, National Federation of Independent Business (NFIB), Caixin, European Commission, Japan Machine Tool Builder’s Association, Association of American Railroads, American Iron and Steel Institute, Department of Labor, Conference Board, University of Michigan, Redbook Research, National Association of Homebuilders, Mortgage Bankers Association​.

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