Global Equities

August has proved to be another volatile month for financial markets. Domestically, the corporate reporting season was in full swing, while global equities continue to be buffeted by the direction of US cash rates, as well as a range of ongoing global economic challenges led by the energy disruption that continues to face Europe.

Further strain has also been placed on both Asian markets highlighted by the  lockdown in the city of Chengdu in China, the ongoing economic weakness against a backdrop of a property market is showing few if any signs of revival and weakening trade flows are proving to be a challenge.

Central Banks

Inflationary expectations continue to rise which is forcing central banks led by the US Federal Reserve to maintain tighter monetary policy. While the US is using higher rates to quote a robust domestic demand, in the UK and Europe, it clearly is a different story with the elevated energy prices requiring the Bank of England and the ECB to raise cash rates as they seek to dampen those inflationary expectations. It’s clear from our perspective, and certainly from the policies of central banks that fighting inflation remains a key priority, irrespective of the negative impact on economic growth.

High Probability of a Global Recession

We now see a high probability of global recession over the next 12-to-18-month period as the impact of higher cash rates filters through the global economy. The PMI surveys in the US continue to reflect an economy that continues to be an expansionary mode, so we expect ongoing rate rises in the US.

Domestically, it remains a somewhat contradictory story. While the Australian labour market remains sound, with the unemployment rate roughly about 3.5% and the second quarter GDP figures also pointing to a robust consumer, building approvals for example, in August were down over 70%. And while the ISM surveys for both the manufacturing and service sectors of the economy remain positive, they are effectively flat month to month.

When we think about a recessionary environment in Australia, the key indicator will be reflected in the strength of the labour market. Whilst the lack of labour supply remains a real issue for the domestic economy, low unemployment does provide some insulation for the economy from the negative impact of both slower growth and higher cash rates.

Bond Markets

Given this conflicting outlook for growth, we were not surprised  to see a significant market sell off in both bond and equity markets throughout August. While the ASX 200 Index was up just over 1% for the month, global equity markets were weaker down anywhere between 2-3% over the month.

Equity Markets

Equity markets were generally weaker over the month, the big negative for investors was in bond markets with a capitulation of performance growth across both global and bond markets continued. Our local bond market index was down 2.5% while global bond markets were also lower down roughly around about 2.5%-3%. Domestic and Global composite bond indices are now down 11.5% and 10.5% respectively, over the last 12-month period.

Rising Cash Rates

This has been an incredibly difficult investment period for investors in longer duration strategies. With central banks still in the early to mid-phase of their tightening cycles, we expect that bond yields will continue to move higher, putting further pressure on the performance returns of fixed income markets.

Given the domestic inflation rate remains about 6% and is likely to move higher over the next quarter as we do envision the RBA will increase official cash rates by a further 75 basis points. As we sit here today, the RBA have increased the cash rate by a further 50 basis points in early September. This will take the official cash rate by the end of the year in our view to roughly 2.60-2.85%.

Portfolio Positioning

Given this outlook for fixed income markets, it’s no surprise that we continue to be underweight in the asset classes at a headline level, with a clear preference towards flexible rate strategies and direct income strategies across our portfolios. However, despite the negative backdrop for fixed income,  which is coming through in higher yields, the spike in the yields has provided some ability for us to selectively add some duration to our portfolios.

With interest rate duration on both domestic and global bonds now over eight years, we think there will be some attractive opportunities as we move forward – once we move past the peak cycle in cash rates and inflation starts to moderate.

Thematic Focuses

The thematic focus we continue to consider at a portfolio really remains on two key aspects.

• Maintaining an investment allocation that’s suited to higher inflationary pressures in conjunction with higher cash rates coming through the system. We continue to play this exposure through overweight positions in alternatives as well as property and infrastructure inclusive of real assets.
• Secondly, at the same time we are seeking to maintain a broad-based investment strategy across the core equity and bond positions. We believe this to be important as this can provide not only further diversification to the portfolios, but equally downside protection.

To this end, our equity positions remain relatively neutral at a headline level although we continue to be underweight, emerging markets and small caps in favour of broad based equity exposures. This is for both domestic and global equities. From our perspective, the need to adopt a flexible investment and asset allocation framework continues to be a key focus from an investment point of view.

Piers Bolger is Chief Investment Officer of Viridian Financial Group. 

Visit our website: www.infinityassetmanagement.com.au

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