Australia Strategy: Asset Allocation Update – Q4 2022

About the author:

Author name:

By Andrew Tang

Job title:

Analyst - Equity Strategy

Date posted:

01 October 2022, 7:00 AM

Sectors Covered:

Equity Strategy and Quant

• Central bank tightening, the threat of energy shortages in Europe, and Covid-related mobility restrictions in China all present headwinds to global growth. As a result, we favour tilting allocations toward parts of the market that should prove more resilient in the event of slowing economic activity.
• We prefer assets with defensive characteristics, inflation protection and lower correlation to the economic cycle. The ongoing volatility and market dislocation will present tactical opportunities, so investors are advised to be nimble with their cash holdings.

As good as it gets

The global economy is headed for a likely recession, but most major central banks will press on with tightening monetary policy for some time yet as inflation remains uncomfortably high. The US economy will hold up relatively well (Fed hikes rates, but Fed says no recession), while much of Europe succumbs to recession as the terms of trade shock from higher energy prices bites.

China’s economy will continue to struggle with a property slump, fading export demand, only limited policy support, and possibly intermittent lockdowns. Energy commodity prices will remain high amid supply disruption and non-energy commodities don’t have much further to fall.

This will make economies that are net exporters of raw materials, such as Australia, the relative winners in what is otherwise a relatively bleak economic outlook. We think the rises in global government bond yields and falls in equity prices have further to run.

Government bond yields have typically peaked shortly before the end of central bank tightening cycles and we expect most major central banks to continue hiking rates over the next 6 months.

We think the increase in government bond yields and the threat of slowing global economic growth will keep risk assets such as equities under pressure. This environment may see some continued widening in credit spreads. We suspect markets will start to turn a corner later this year as tightening cycles near terminal levels.

Seek protection outside of the core

We expect volatility to remain higher for all asset classes. We are a few quarters away from being confident that central bank policy and inflation pressures are controlled. We stay underweight global equities, with a focus on those resilient to an economic slowdown, we continue to see ongoing risk in Asia and Europe.

High fixed income volatility is expected to moderate in the near term, but significant challenges remain, and we remain underweight. While we see ongoing risk to core assets such as equity and fixed income, we see an allocation to alternative assets as a way to diversify portfolio risk.

Due to the low correlation of returns against equity and bond indices, alternative assets have the potential to offer diversification benefits in a multi-asset portfolio of long-only funds in traditional assets.

For more conservative portfolios, alternatives can play a valuable role in increasing the prospective return, without adding to equity market risks. See our full publication for preferred exposures. We list our preferred exposures on page 3.

Key changes to our asset allocation settings

We cut risk exposure this quarter, increasing our underweight to global equities. We don’t believe the market has fully discounted higher interest rates and the risk to earnings from a global slowdown.

We maintain our neutral position to Australian equities. In our view, the resilient earnings outlook assisted by higher commodity prices will see Australia outperform global peers. We overweight cash as we see the risk of heightened volatility over the next few months.

Figure 1: Morgans recommended asset allocation settings

Source: 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.