Australia Strategy: Asset Allocation Update – 2023 Outlook

About the author:

Andrew Tang
Author name:
By Andrew Tang
Job title:
Analyst - Equity Strategy
Date posted:
07 December 2022, 7:00 AM
Sectors Covered:
Equity Strategy and Quant

  • Lower valuations mean that asset markets today offer much better prospects for returns in 2023. It took a painful slump in 2022 to get there and challenges remain but we think those with a long-term horizon will be well rewarded.
  • We step down our defensive positioning as we are near the inflection point for the current inflationary wave and the prospect of a pivot in China’s zero-COVID policy could pave the way for a revival in risk appetite.
  • We reduce our overweight cash position and bring fixed income back to neutral.

Are we there yet?

Markets have faced a tumultuous 2022 as a new regime of higher macro volatility took shape. The key question for 2023 is whether central banks can tame inflation to more acceptable levels without a recession, or at least without a deep recession.

We are reasonably optimistic, but there are substantial risks. Suppose inflation pressures remain pervasive enough that central banks have no choice but to keep tightening aggressively. In that case, a recession might become unavoidable, not just in Europe but also in the US.

Beyond the inflation concerns, political and geopolitical shocks could continue to affect markets via higher uncertainty, tighter financial conditions or negative effects on commodity supply. However, risk presents opportunity, and we see a path for investors to succeed in the new regime.

Investing in the energy transition, Australian equities with a value/quality bias, investment grade credit, and alternative sub-classes offer the best risk/return profile for a market fretting about what is to come.

Don’t forget about fixed Income

Fixed income markets have had a challenging 2022. But in a slowing economic backdrop that sees growth fall and central banks turn less hawkish, a quality oriented bond portfolio could play an important role for returns and diversification in 2023.

This will be especially true if stock/bond correlations turn negative again. But in 2023, investors no longer benefit from policy-based shock absorbers, like quantitative easing or artificially low rates, to protect their portfolios.

From an implementation perspective, this means a higher credit quality portfolio and companies with strong fundamentals, a healthy cash flow and lower leverage.

China: could a parallel pivot story be playing out?

China’s COVID policy ‘pivot’ can potentially be a major driver of asset prices in 2023. We see a possible end to the zero-COVID policy in 1H23 as economic challenges and social unease are likely to prompt change.

A re-opening could allow consumption to rebound sharply and boost GDP. Importantly, as China pursued a very different policy response to COVID from most of the West, it is not experiencing high inflation or rising interest rates. This gives Beijing a significant runway for stimulus.

Key changes to our asset allocation settings

We increase our risk exposure this quarter, decreasing our overweight cash position and bringing fixed interest to neutral weight. While we increase our risk exposure, we maintain an underweight exposure to global equities.

This is because we don’t believe the market has fully discounted the risk to earnings from a global slowdown. We take a more constructive view on Australian equities supported by higher commodity prices and strong employment conditions which should see the Australian equity market outperform global peers.

Figure 1: Morgans recommended asset allocation settings

Growth stocks have had a choppy ride since the onset of the pandemicSource: Morgans Financial

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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