Prudential's Head of Global Investment Solutions (Asia Pacific) and Fund Manager, Thomas Poullaouec, along with the Prudential Asia Investment Committee, recently shared their global asset allocation insights. They noted that, aside from the long-term negative impact of a U.S. government shutdown on the economy, the absence of official data poses ongoing challenges for the Fed, which relies heavily on data for its decisions. The Fed's recent interest rate cut has sparked renewed attention on small caps, but inflation might keep rates elevated, along with a weak labor market potentially leading to slower growth, justifying a balanced view on small caps.

The commentary highlighted that the Fed's first interest rate cut since it halted rate hikes at the end of last year has shifted market focus to employment conditions. Data from August indicated a rebound in job growth, with the unemployment rate exceeding a four-year high of 4.3%. Investors are closely monitoring the September data, although its release has been delayed. Revisions to last month’s data showed a 910,000 reduction in job growth from April 2024 to March 2025, raising concerns and questioning the reliability of employment figures. In the absence of official data, market data becomes increasingly critical. The ADP report for September indicated a loss of 32,000 jobs, deepening concerns about employment.

As release times for data extend, the probability of more alarming figures increases. In recent years, expectations of rate cuts have intermittently driven interest in small caps, allowing them to outperform large caps, although this momentum has not lasted. Following the Fed's recent rate cut, small caps have outperformed large caps by nearly 4% since their low in April, with most gains occurring in August. While relative valuations for small caps remain favorable and profit expectations have improved, inflation risks maintaining elevated rates coupled with a weak labor market may lead to slower growth; hence, a balanced economic outlook is advisable.

In light of expected Fed rate cuts, increased M&A activity, and a more favorable regulatory outlook, Prudential has adjusted its allocation to U.S. small caps to neutral. This adjustment shifts Prudential’s allocation stance on large caps (relative to small caps) to neutral and raises the overall equity allocation to a high level. Prudential is also leaning towards growth stocks as the macro environment continues to support the AI/technology sectors, especially in the U.S. The firm maintains a low allocation to bonds due to inflation and financing demands from U.S. fiscal stimulus likely putting pressure on rates, particularly at the long end of the yield curve. They have opted for a low allocation to long-term U.S. Treasuries as the long end of the yield curve is more susceptible to upward pressure from U.S. government financing needs. Additionally, cash allocation is diluted to neutral in order to fund allocations to U.S. small caps, providing liquidity to seize opportunities amidst market dislocations.