Oh Value, where art thou?

In our global asset allocation, we are overweight equities and underweight bonds. The U.S. and China are in a trade truce. The Fed is supporting the economy via rate cuts, and we now see a 60% probability of a soft-landing in the U.S. economy, up from 55% at the end of September. The earnings season in the U.S. has been solid, both in terms of numbers and guidance. This environment means it is easier to find opportunities in equities, but there are still areas of interest in bonds.

Adding gold and gold miners

For equities, the most interesting new opportunistic idea lies in the gold mining sub-sector. This segment offers a more geared route to express a bullish view on gold.

To recap, the current pullback in gold represents an opportunity to add exposure because the structural drivers of the gold rally remains intact:

Geopolitical uncertainty, leading to Emerging Markets (EM) consistently boosting their gold reserves in the past three years, especially after the U.S. and EU decisions to freeze Russian central bank assets following the start of the Ukraine war in early 2022. The top three EM central bank gold holders – China, India and Russia – have 6.7%, 13% and 36% of their reserves in gold;
Concerns about expansionary fiscal policies worldwide, and U.S. fiscal policy, which can hurt the USD. The Tax Policy Centre estimates that the latest U.S. budget (the “One Big Beautiful Bill”) would add USD 4.2tn to the U.S. federal debt, or 9% of GDP, by 2034;
Increased doubts about the Fed’s independence.

In terms of fundamentals, the gold miners are enjoying expanding profit margins as the rise in gold prices has been outrunning increasing costs. This is leading to surging free cash flow, which enables companies to increase share buybacks, raise dividends or pay down their debt – all these are positive for shareholders’ returns and the health of the company balance sheets.

Another new opportunistic idea is U.S. pharmaceuticals. This sub-sector’s valuation is inexpensive versus the broader U.S. market, as it trades close to one standard deviation discount in terms of relative 12-month forward price-to-earnings ratio. Regulatory uncertainty is a major headwind, but this risk is receding as pharma companies are agreeing on pricing and tariff concessions with the Trump administration.

Lastly, we have a new opportunistic idea on U.S. utilities, which also offer defensive earnings growth and reasonable valuations. Earnings growth is accelerating. The U.S. electricity demand is likely to grow at twice the pace over the next decade — the demand growth is due to data centre boom caused by AI developments.

Seeking returns in select bonds

In bonds, the environment is more nuanced. One of the most interesting statistics is that U.S. government bond yield is equivalent to 95% of the nominal yield on U.S. corporate bonds. The credit spread, or the extra yield you get by holding corporate credit over government bonds, is very close to its historical lows. There is limited room for this credit spread to tighten further.

In other words, the currently tight corporate bond yield premia makes the risk-reward balance on holding corporate bonds unattractive. Hence, we have moved corporate bonds to an underweight in our asset allocation.

However, there are still pockets of value within Developed Market corporate bonds. We are still bullish on U.S. short duration high yield bonds. The key word lies in “short duration”, which are typically shorter maturity bonds whose prices are less volatile than the broader high yield bond universe, because default risk is lower for shorter maturity debt.

Asian U.S. dollar-denominated investment grade bonds are another attractive area for investors currently. The yield premium on government bonds is tight, but fundamentals are strong. Moreover, technical factors are supportive. For example, there is negative net issuance of these bonds i.e., new issuance is not keeping pace with the speed of maturity or redemption. “Economics 101” says if demand remains intact, and supply declines, this backdrop provides good tailwind for the prices.

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