• A new regime of heightened volatility is playing out. The impact of higher interest rates is starting to be felt and counting on broad market moves won’t do now, in our view. That shift comes as US and European economies enter a period of stagnant economic growth. But we don’t see central banks coming to the rescue with rate cuts.
  • We see opportunities in relative pricing and structural trends. We maintain a slightly cautious tilt this quarter: overweight cash, underweight Developed Market (DM) stocks and neutral fixed interest/Australian equities. But we are ready to seize opportunities as macro damage gets priced in.

Patience required

The combination of faltering economic growth and central banks still focused on above-target inflation will remain a challenging backdrop for most risky assets.

The recession now taking hold across advanced economies means some short-term pain is in store: risk assets, such as equities, will not turn the corner decisively until the economic outlook in the US brightens, even if safe asset yields fall a bit further in the interim.

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 near fully invested given our view that the inflection point for risk assets will be difficult to time.

China’s recovery stalls but stimulus will aid growth in 2H 2023

After a promising start to the year, China's economic growth has recently slowed down, falling short of expectations as shown by recent weakness in key economic data. The central government had anticipated a post-COVID recovery in consumer spending that could drive growth to the c5% GDP growth target. However, due to concerns about housing market stability, this recovery faltered.

To address the issue, key interest rates were reduced to encourage banks to lend and kick-start a recovery in the real estate sector, which accounts for more than a quarter of China's economy.

At this stage, stimulus looks set to be fairly modest, so the near-term outlook still depends primarily on the extent of second-round effects on consumer confidence and spending.

Still, we remain cautiously optimistic that stimulus will support the recovery in 2H 2023 more than most anticipated. We play the recovery through Australian Resources and overweight to Emerging Markets equities.

Think small

Since the start of 2022 small companies have been in a downward trend with MSCI global large caps outperforming smalls by 9% over the past two years. Rising interest rates, market liquidity and falling investor sentiment have institutional and retail investors alike shying away from this segment of the market.

While it’s too early to call the bottom, we think there are good reasons for reallocating to small companies:

  1. Fundamentals have broadly improved post-COVID.
  2. Recent trends point to an improvement in liquidity.
  3. Small companies typically offer superior earnings growth relative to large cap peers.

Key changes to our asset allocation settings

We maintain a cautious tilt this quarter: overweight cash, underweight developed market (DM) equities and neutral Australian 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 with a bias toward small caps. Resilient commodity prices and strong employment conditions should see the Australian equity market outperform global peers.

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.

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