DBS sees risk assets in ‘sweet spot’ as inflation moderates and rate cuts loom

THE current economic environment is in a “sweet spot” for risk assets, said DBS senior investment strategist Daryl Ho, citing moderating inflation and the potential for gradual interest rate cuts as key drivers of market optimism.

He was addressing 120 attendees at the bank’s Market Outlook 2025 – Beyond New Frontiers event on Wednesday (Dec 4) at the Sands Expo & Convention Centre.

In his presentation, he drew parallels between today’s economic conditions and those of early 1995, noting similarities in inflation, consumer spending and wage growth.

“In 1995, the US economy was doing pretty well, and the Fed (US Federal Reserve) was also on a gradual rate-cutting process,” he said. “Risk assets, like equities, didn’t perform very well in the years looking forward.”

Despite this historical caution, Ho expressed confidence in the current outlook for equities and bonds, underpinned by expectations of further easing inflation.

He anticipates that the Fed will have room to cut interest rates, although the pace may not be as aggressive as earlier anticipated.

The central bank lowered interest rates by 25 basis points in November, bringing them to a range of 4.5 to 4.75 per cent, after a more substantial 50-basis-point cut in September. The Fed’s next meeting is scheduled for Dec 17 and 18.

“We think inflation will come down, and this gives room for the Fed,” Ho said, adding that this environment could prolong the ongoing rally in risk assets.

Bonds and S-Reits shine

Ho was also optimistic about fixed-income assets, highlighting the attractive yields available across various segments.

“You can actually take less risk and get higher income than what you are used to, which is why we are very positive on bonds,” he noted.

The bank’s analysis shows that bond yields are currently well above historical averages, offering investors a buffer against potential market volatility, Ho said.

Interest rates would need to rise significantly before bond investments turn negative, he explained. “You will only start to lose money in bonds if the Fed does a complete U-turn and hikes four times.”

Even if rates remain unchanged, DBS expects returns of around 5 per cent, with potential gains of between 9 and 13 per cent if rate cuts materialise.

Beyond bonds, the bank also views Singapore real estate investment trusts (S-Reits) as a compelling income-generating asset.

Ho pointed to a nearly 300-basis-point yield gap between S-Reits and 10-year Singapore Government Securities (SGS) bonds, suggesting a favourable risk-reward balance for investors seeking stable returns.

The gap reflects the premium investors receive for taking on additional risk, compared to the risk-free rate of SGS bonds.

“If you want to go to S-Reits, remember the frame of quality growth, income generation, and risk,” Ho advised.

Gold has also emerged as a standout performer in DBS’ asset allocation strategy, with prices up around 28 per cent year to date.

Ho attributed this strength to structural demand beyond interest rate considerations, driven by central banks increasing their allocations.

“We think (that) there’s a lot of mean reversion, meaning that the central banks are now increasing their allocations back to historical norms,” he said.

Balanced portfolio strategy

The bank continues to advocate its “barbell investment” framework, which balances quality growth assets with income generators.

Currently, 46 per cent of DBS’ portfolio is allocated to equities – with a focus on innovative US companies – while 40 per cent is in bonds.

“The bulk of our equities allocation goes to the US because that’s where we find the most innovative companies,” Ho explained.

However, he cautioned against speculative investments, referencing the rise and fall of non-profitable tech companies in 2021.

And as investors navigate an environment of moderating inflation, potential rate cuts, and market uncertainties, DBS remains optimistic that a diversified and balanced portfolio can deliver steady returns.

“We do think that this supports the notion that risk assets are in a sweet spot and will likely continue to do well as the economy continues to charge forward,” Ho said.