- The US economy has remained resilient supported by robust job gains and consumer spending. The Fed’s aggressive rate hikes will slow the economy and lead to a slowdown into year-end. US consumer spending will likely fade now that excess savings are depleted and job growth moderates. We think investors will do well playing defense to close out 2023.
- This quarter, we increase our cautious tilt: overweight cash, and underweight risky assets including Global and Australian equities, and real assets. We remain balanced on fixed interest.
Treading carefully over the next 3-6 months
The surprising resilience of economic activity in the first half of 2023 is unlikely to last: we forecast a slowdown in the major advanced economies as the effects of tighter monetary policy feed through and China’s recovery falters. Expansionary US fiscal policy which has fueled risk assets over the past few years is contracting, hitting commodities prices and curbing economic growth.
We fear the next leg down will be corporate profits. Given Australia’s economic sensitivity to falling commodity prices, investors need to tread carefully over the next 3-6 months. As inflation pressures start to fade and growth slows, attention will increasingly shift towards policy easing.
Policy rate cuts are unlikely until some way into 2024, but once they start, they will be more rapid than what is currently priced in. Overall, our more cautious view on growth does not appear to be discounted in financial markets.
This suggests that the outlook for risky assets is poor in the near term as risk premia, which now appears relatively low, is likely to widen again and earnings expectations are disappointed.
However, poor investor sentiment and elevated cash levels will ensure a relatively short-lived pullback in asset prices, so it’s important to remain nimble. Our tactical position retains higher cash but remains invested given our view that inflection points for risk assets will be difficult to time.
Looking further ahead: AI – what’s all the fuss about?
Given its wide range of potential applications, the new breed of AI tools would appear to have all the characteristics to become a standalone general-purpose technology (GPT). In the next phase of AI innovation, we expect smaller firms to lead the way in developing tools that integrate the new technology into workflows and add-ons to existing software.
Generative AI in particular, have the potential to revolutionise how cognitive tasks are performed by knowledge workers mostly, but not exclusively, in the services sectors.
This revolution is already well underway in the software industry and, within the next few years, will spread quickly in other areas such as education, translation services and medical diagnostics.
The process will create winners and losers across sectors, with the impact determined by the speed and extent of adoption. We believe that the revolution in AI is likely to be a positive for stock markets, especially for sectors and countries that are key providers – notably US AI application developers and advanced semiconductor manufacturers.
One reason is that we expect the revolution to result in even faster growth in earnings than in output. Another is that we think rising stock valuations will accompany it.
Key changes to our asset allocation settings
This quarter, we increase our cautious tilt by adding to cash (+6%) and reducing exposure to risk assets (Australian Equities -3% and Real Assets -3%).
Figure 1: Morgans recommended asset allocation settings
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