Macro Matters June 2022

(Source: Merlea Macro Matters)

Summary

The prospects of prolonged inflation and slower economic growth are rising, with added supply-chain risk from sanctions on Russia, China’s pandemic lockdowns, and tighter labour market conditions in general. The severity of labour shortages and associated wage pressures varies across APEC economies, with, for example, Australia being more exposed than China and Indonesia. There are some signs that the most extreme supply-related pressures are easing, but categories where price changes tend to be more persistent—such as housing and food—now account for a larger portion of inflationary pressures. Continued increases in wage growth and inflation expectations represent a worrisome trend that over time could become a self-reinforcing wage-price spiral that leads to persistently high inflation.

The pre-pandemic trend of rising long-term inflationary pressures has been exacerbated over the past two years. The use of low interest rates and high fiscal deficits appears entrenched, supply-side pressures from de-globalisation trends are manifest, and the exit of older workers from the labour force underscores that an aging demographic is not inherently deflationary. Secular inflation risks imply a need for greater diversification. As a result, stagflation is now back in the news.

Stagflation refers to an unusual period of high inflation with low, or in extreme circumstances, negative economic growth. Many investors have never experienced such an environment. The most recent stagflation experience was back in the 1970s, where inflation rose to as much as 12 per cent, mostly caused by the oil price spike. As the name suggests, stagflation would be a very uncomfortable period for households and corporates as real income shrinks and begins to drive demand destruction.

Once this spiral of rising inflation, falling real incomes, and weakening demand becomes entrenched, the economy goes into a negative spiral that is hard to reverse. As early as the start of the year, this seemed liked an unthinkable scenario for the global economy and/or Australia, but a lot has changed. While the fundamental outlook appears strong for Australia, it is important to consider inflation. Unlike the US, our core inflation remains subdued partly due to lockdowns and the structural differences in the labour market.

Australia’s inflation will certainly pick up and during the last reporting season many companies talked about increasing prices, however we expect Australia’s interest rate increases to be slow and steady, and well below levels seen before the pandemic at least out through the middle of 2023. With financial conditions a long way from being tight, this is not nearly enough to push us into recession, as stagflation will suggest.

The Australian market has proved to be defensive with this backdrop, outperforming the international benchmark. We are beginning to see opportunities across many quality companies that are mostly domestically focused and are growing earnings in a meaningful way.

Bonds

I think we have witnessed this year the biggest secular change in the bond market in over forty years – where yields declined in a one-way direction. The primary trend is clearly higher, and I believe bonds in the US and globally, are now in a secular bear market. During the second quarter of the year, the bond market will continue to find itself between a rock and a hard place. While the Federal Reserve will actively engage in aggressive monetary policies to curb inflation, geopolitical concerns will add upward price pressures and fears of slower growth. Thus, volatility will remain elevated, causing more widening of credit spreads.

The most significant difference between the first and second quarters of 2022 is that while bond yields surged on monetary policy expectations at the beginning of the year, now markets need to consider what central banks will do. Policy decisions will not be confined only to interest rate hikes. They will touch upon other tools such as the runoff of their balance sheet, forward interest rate guidance and their economic outlook. If central banks disappoint market expectations, the risk of entrenched sustained inflation becomes higher; if central banks overtighten the economy, the risk of a recession increases.

Whether you want to admit it or not, we have entered a bond bear market, where yields are destined to increase substantially. In this environment, traditional safe havens like US Treasuries will not protect investors looking to diversify portfolios. Duration will be even more toxic than at other times in history because we are starting off from record low interest rate levels and there is no higher income to fall back on. This is a result of years of accommodative monetary policies, which distorted risk perception and forced investors to take on more risk either through credit or duration.

Therefore, the chances for a tantrum in credit markets has increased. The good news is that following a dark period of uncertainty and volatility, a new and better equilibrium will be restored, enabling investors to rebuild their portfolios at much better market values.  Since the beginning of the year, US Treasuries have suffered from the most significant losses compared to any year since 1974. Their weak performance is attributable to bets on interest rate hikes for 2022. However, the situation has recently become more complex. With the rise of geopolitical tensions, investors have been divided between high inflation and a slowdown in growth.

That is a massive headache for the Federal Reserve, which originally envisioned tightening the economy in an expansion as inflation was peaking. Right now, it’s difficult to say when inflation will be peaking, while it’s inevitable that the economy will slow down. The Federal Reserve needs to redirect its efforts to fix one of these two problems. We believe that it will work towards containing inflation at the cost of growth this time around.

Indeed, inflation expectations in the US have recently soared to record new levels across the curve, showing that high inflation is becoming more entrenched than initially thought. In the short term the 10-year yield, which has fallen back to 2.72% points to near-term inflationary risks being more than adequately priced in. While the Federal Reserve has maintained a hawkish line on inflation, in the minutes from the May meeting released last week, it left a window open for a pausing in the tightening cycle, if the economy begins to weaken.

Listed Property

More than two decades ago, the arrival of “dot coms” set in motion profound changes that have touched every industry, including real estate. Demand shifted from retail centres to warehouses and data centres, while more flexible work arrangements changed the dynamic for office space.  Then Covid-19 accelerated all these trends, prompting a dramatic—and in many cases permanent—shift in consumer, employee and organizational behaviours and norms. Now that hybrid and remote work is part of the vocabulary and no longer an exception, real estate is undergoing a permanent shift.

Office property in many cities and business-focused hospitality continue to suffer impaired demand and values. However, the actual impact on office demand will vary by city and an increased focus on health, wellness and safety could serve as a partial offset to demand impairment; a nuanced approach to top-down trend analysis will be necessary for active managers. Office utilizations globally recently ranged from approximately 15% to upwards of 70%, with some of the lowest utilization in San Francisco, Seattle, and New York, and some of the highest in Stockholm, Paris, and Hong Kong.

Similarly, essential business travel will return, but likely not to pre-pandemic levels, as corporations appreciate the cost efficiency of virtual environments. That said, leisure travel has, in many places, recovered to 2019 levels. We’re also seeing notable regional differences, based in part on vaccination rates and local travel mandates. Retail has experienced a significant secular decline as e-commerce has shifted demand from storefronts to warehouses, data centres and logistics.

Here too, there has been a disconnect between the growth of overall retail sales and demand for retail property. However, there now is a renewed appreciation for the storefront as retailers rethink the role of the physical storefront in distribution and, in some cases, brand development.  There will likely continue to be square footage rationalisation as e-commerce grows, but brick-and-mortar retail isn’t going to zero. The pandemic has underscored the importance of a physical location in a true omnichannel distribution environment. Consequently, retailers are reinvesting in their stores and looking to sign leases in premium retail centres globally.

With absolute interest rates likely to stay lower for longer, the search for yield is and remains intense. Among the universe of investable asset classes, real estate offers some of the highest yields, second only to global high yield bonds.

Australian Equities

In a global sense, Australian Equities have been more resilient, largely thanks to higher commodity and energy prices. Whilst the market is closely following what transpires between Russia and Ukraine, the longer-term focus clearly remains on inflation and interest rates. In a global sense, the Australian economy has been quite far removed and relatively well protected from the impacts of the Russia/Ukraine war. As at the commencement of the war, our total exports to Russia accounted for < 0.1% of total GDP.  Australian energy and key commodities have also helped to fill the supply gap left by the disruptions to Russian and Ukrainian exports, providing a boost to national income.

The Australian economy is looking in better shape, with employment levels reaching all-time highs and household balance sheets in good shape (despite elevated mortgage debt). Inflation domestically has also been more contained and business confidence is building, with Australia delivering stronger GDP growth than most global peers.

Australia’s stock market outperformed global equities in Q1 as its coal, LNG, iron ore, gold and agricultural equities. I think momentum will continue in Q2 with mining and agricultural stocks primed to strengthen amid higher prices and accommodative China policy. Australia boasts one of the highest trade surpluses (exports minus imports) in the G20 Countries. It’s also likely to have one of the strongest economic growth rates in the G20.  This is all thanks to Australia being the world’s largest iron ore mining country; the second-biggest LNG exporter. The third-biggest uranium producer; the fourth-biggest coal nation; the fifth-biggest copper and lithium producer and the sixth-biggest wheat and other grains exporter. Australia is benefiting from commodity prices surging. The iron ore price is up 28 percent so far this year, oil is also up 36 percent and wheat are up 41 percent (as of May 29).

Australia’s exports surged to AUD 49.3 billion in January (the most recent reading). On top of this, prices are poised to rise over the longer term, amid anaemic supply and roaring demand, further benefiting Australia; this will attract more foreign money. This will support the Australian dollar. AUD will trend towards the upper end of the band over the rest of 2022.

The economic challenges facing Australia after the election

The spike in the price of oil, gas and coal has delivered a national income boost via Australia’s commodity exporters. But that windfall comes at the expense of higher fuel and food costs for households.

Headline inflation of 5.1 per cent is tipped by the RBA to hit 5.9 per cent late this year. The central bank’s preferred underlying inflation measure – which strips out major price movements such as for fuel and food – is expected to remain above its 2-3 per cent target band until mid-2024. Markets are betting that the RBA’s 0.85 per cent cash rate will surge to 2.6 per cent by December. That would mean a rise of more than 0.25 of a percentage point each month for the rest of the year. Most market economists forecast a slightly lower rise in the cash rate – to just less than 2 per cent by December.

Global markets

America

Markets had to pivot fast in early 2022. At the start of Q2, markets have priced in the most aggressive Fed rate hike cycle since the mid-1990s, quantitative tightening, surging geopolitical uncertainty, higher inflation expectations and concerns about what all this will mean for the economy. It’s a lot to digest, so it isn’t surprising that volatility has ratcheted up.

As the Fed has rapidly turned more hawkish, markets have become convinced that policymakers will overshoot and be required to reverse course and adapt. In January, markets were looking for just five rate hikes total in 2022 and priced in no further Fed action thereafter. Now, markets are pricing in eight to nine rate hikes spread over the remaining seven meetings in 2022, with the Fed funds peaking inmid-2023, quickly followed by rate cuts in 2024.

The Fed is raising rates to address inflation, but unlike markets that react in real time to shifting rate hike expectations, the economy reacts to higher rates with a lag of four to six quarters.

Housing is among the most interest rates sensitive sectors of the economy. Higher yields have already materially impacted the cost of financing, pushing the 30-year mortgage rate above 5% for the first time since 2011. While this has sapped affordability and threatens to slow the market, there are reasons to believe housing will not be as sensitive to higher rates as in the past. There are early signs that higher mortgage rates are causing buyers to hesitate. Purchase mortgage applications have fallen sharply in the past two months and refinancing, a source of funds on the margin for households, have dried up. The level of existing home sales, while still elevated, has declined roughly 9% since the January 2021 peak. And buyer sentiment is, predictably, low—63% say now is a bad time to buy, the highest since the early 1980s. Quantitative tightening (QT) also looms as a policy uncertainty—and potential challenge—for markets.

In May, the Fed plans to quickly begin to ramp up QT and soon allow $60 billion of Treasury assets and $35 billion of mortgage-backed securities (MBS) to run off each month. This is almost twice as fast as the run-off rate of prior QT. (As last time, the Fed does not initially plan to sell securities, but instead rely on run-offs.) Because so many reserves are currently held in the Fed’s own repo facilities, the Fed’s expectation is that significant reduction can be accomplished without causing a liquidity crunch in financial markets. But volatility in benchmark interest rates rise has already increased significantly and stands to reverberate more significantly to broader markets.

Unlike quantitative easing—which has become a staple of the Fed’s toolkit over the last 15 years—QT has only been attempted once, and in 2019 ended with an explosion of volatility that caused a fast reversal. QT adds to the probability that the Fed’s aggressive policy tightening will overshoot.

For equities, we expect the focus to be on fundamentals in Q2. Multiple compression has been swift due to higher long-term interest rates and Fed rate hike expectations. But a strong economy and solid nominal growth mean that margins may remain well supported. While the indexes are unlikely to see valuation multiples expand, it is important to allocate to those industries with the strongest fundamentals.

Europe

The Russia-Ukraine conflict is hitting economies worldwide just as activity is recovering from COVID-19. As close neighbours to Russia and Ukraine, European countries are among the most exposed to the latest shock. Yet, the eurozone economy is coming out of the pandemic in a position of strength, with large buffers to protect itself against a full-year recession, unless severe downside assumptions materialise.

While the initial second-round effects on inflation may be relatively muted–with workers potentially worrying about job security–the rise in food and consumer durable prices is more likely to lead to a more sustained increase in inflation expectations. Those have already moved up in the past months. Higher price pressures are also likely to develop in coming years from structural trends, such as the reshoring of supply chains, in response the pandemic and tensions with Russia as well as the need to transition away from fossil fuels.

Oil and gas prices have increased markedly since the beginning of the conflict, adding to already high inflationary pressures in the eurozone. Over the past six months, energy prices contributed to more than one-half of headline inflation pressure.

The ECB will start withdrawing monetary policy support as the eurozone moves away from the low-inflation regime of the pre-COVID-19 years and if the growth effects of the Russia-Ukraine conflict remain contained. Thus, after it phases out net purchases in the third quarter, we expect the ECB to raise rates 25 basis points a quarter from December until they reach 1.5% by mid-2024.

At first glance, European stocks are trading at attractive valuations. But, European strategists caution, prices may not yet reflect all the bad news.

In fact, while the index price-to-earnings ratio was recently in the low double digits, it has dipped into the single digits twice over the last 15 years. “And while MSCI Europe trades at a record-low relative valuation to the S&P, its relative valuation against MSCI ACWI ex US is actually above average,” says Graham Secker, Head of the European Equity Strategy Team.  Further, European economists have revised their GDP forecasts lower, and their inflation estimates higher, and at a time when the European Central Bank is beginning to remove policy stimulus. Against this backdrop, we think that the risk/reward profile for MSCI Europe remains unattractive.

United Kingdom

Pressure is mounting on the government to deliver an emergency summer minibudget after recession fears were heightened by a surprise contraction in the economy in March. Evidence that the cost-of-living crisis was biting even before the arrival last month of dearer energy bills and higher taxes led to a sharp selloff in shares and a drop in the pound’s value to a two-year low against the US dollar.

Boris Johnson pledged that the government would “do things” in the short term to ease the squeeze on living standards without providing any hint about what the measures might be. His pledge came amid growing speculation that the economy would fall into recession – two successive quarters of negative growth – over the coming months.

Converging valuations in the UK and the euro area are making the FTSE 100 Index less attractive compared to last year.

Japan

With the Japanese economy still burdened by COVID-19 restrictions and higher commodity prices, worsened by depreciation of the yen, GDP declined in Q1 2022 by a seasonally adjusted 0.2% q/q in real terms.

Japan announced a JPY 6.2tn (USD 48bn) emergency economic stimulus package on April 26, 2022, to lessen the impact of an increase in prices on households and smaller firms, which is partly due to the conflict between Russia and Ukraine affecting global commodities. In its latest Quarterly Outlook Report, for April 2022, released on May 2, the BoJ observed that inflation in Japan will be pushed upwards in 2022 because of higher energy and food prices. The surge in commodity prices is expected to impact the economy with a lag because Japan’s utility companies set electricity prices based on the average import cost from several months before.

This, in turn, will keep inflation elevated in the second half of the fiscal year ending March 2023, according to the BoJ. The central bank further observed that the rise in input costs, if passed on by companies to consumers, could keep food prices elevated as well, thus feeding into a possible rise in overall inflation.

Despite the rise in inflation, the central bank has decided to persist with an ultra-loose monetary policy by keeping its policy interest rate negative. At the monetary policy meeting on April 28, 2022, the BoJ maintained its monetary policy stimulus by continuing to buy unlimited amounts of 10-year government bonds at 0.25%. It also decided to maintain its guidance on keeping its interest rate targets at current or lower level. By adopting these measures, the BoJ indicated that it was willing to go to great lengths to stimulate Japan’s economy.

The Japan government announced a JPY 6.2tn (USD 48bn) emergency economic stimulus package on April 26, 2022, consisting of four pillars – containing oil prices, ensuring a stable food supply, providing support for small and medium-sized companies and helping struggling households.

Among key support features in the package are increased subsidies for oil wholesalers to bring down retail petrol prices and support for struggling small- and medium-sized companies, along with livestock farmers. Furthermore, the package will offer cash handouts of JPY 50,000 per child for low-income households. This stimulus package had been expected as a surge in food prices and fuel inflation were seen to be hurting consumer sentiment in Japan after it bounced back from the negative impact of the pandemic.

Unattractive risk/reward profiles are also a common theme through much of Asia, including China. However, Japanese equities continue to be a notable outlier. Valuations are low, return on equity is approaching a 40-year high, and earnings are boosted by Japanese yen weakness. Meanwhile, the macro-economic outlook is relatively positive. GDP growth, while modest at 1.9%, is an improvement over 2021; the country has low inflation and a central bank on hold. Under their base case, strategists see the TOPIX returning 9.3% over the next 12 months.

China

China’s stated growth target for 2022 is 5.5%, which is arguably optimistic given the first quarter. China’s stringent pandemic response, which has caused broad citywide or regional shutdowns when just a few cases are found, has been a headwind for the household consumption since the pandemic began. Now, as the Omicron variant tears through Shanghai, the China’s zero COVID policy increasingly looks too costly, and unsustainable. And yet, it may remain in place for the rest of the year. The impact on the economy is already apparent and will likely worsen in May.

The Caixin Manufacturing Index hit 48.1 in March, the lowest since February 2020. The NBS manufacturing PMI hit a five-month low in March, with declines in the production and demand indices outside of COVID, China’s property woes of last year have continued, and house prices have been falling since Q3 of 2021.

This creates another headwind to consumption, as homes comprise a huge portion of Chinese household wealth. Finally, exports provided a powerful source of growth in 2021 but have begun to decelerate. This could continue as growth in the U.S. and Europe moderates while higher commodity prices will keep import prices elevated, likely lowering China’s trade surplus in 2022.

Combined with the crackdown on property speculation, this leaves infrastructure spending as the likely driver of growth this year. Monetary policy has turned stimulative, and there is room for more, but the scope may be modest. Fiscal stimulus will also add support, focused on the housing market and manufacturing. However, we expect China to miss its growth target for 2022. Ultimately, China will have to choose between Common Prosperity and zero COVID.

In terms of monetary policy, mild consumer price inflation will encourage China’s central bank, the People’s Bank of China (PBOC), to maintain its current accommodative monetary policy to support the economy. Although high producer price inflation requires monitoring, the PBOC has become more concerned by financial risk than inflation, endorsed by the recent high-profile defaults in the property sector.

Through its open market operations, the PBOC did not inject or withdraw any liquidity into China’s interbank market in Q1-2022, which compares with a net withdrawal of RMB 510bn in the same period of last year. Another round of Reserve Requirement Rate (RRR) and Loan Prime Rate (LPR) reductions may be needed to achieve the GDP growth target for2022

After a year in which China’s equity markets were held back by concerns over rate rises and increased regulation, the government has shifted decisively towards pro-growth policies. This creates a brighter outlook for equities in the second half 2022. Even though the policy backdrop is becoming more supportive for equity markets, important risk factors remain.

Emerging markets

Since the start of the Russia-Ukraine war in February, the impact has been disparate across emerging markets. The emerging European (Hungary, Poland, Czech Republic, Greece, Turkey) and Egyptian equity markets have been some of the worst performers given their dependence on Russian energy, grains, and tourism.

On the other hand, with Russia no longer part of the MSCI Emerging Markets Index, Latin American markets have benefited from higher commodity prices. Beyond Latin America, Saudi Arabia and South Africa have also recorded strong performance as they have the next-largest market exposures to commodities. In contrast, the market exposure to commodity sectors is considerably smaller in Asia, at only 10%, which is one reason the region has lagged. Over the short term, it is likely that market volatility will persist given the increased geopolitical uncertainty, weaker global growth, and earnings risks from oil shocks and higher inflation.

Encouragingly, since the end of 2020, lower-valued shares with higher dividend yields and free cash flow yields in emerging markets equities have become more sought after. These improving characteristics, along with the lower valuation multiples versus its own history and compared to developed markets, could present investors with an attractive entry point into the asset class.

Commodities

Rapidly surging global inflation, Rate Hikes and Geopolitical Risk are now emerging as the three major themes dominating and driving the financial markets.

Oil prices soared above $130 a barrel to hit their highest level in a decade. While Gold extended its rally from just under $1,800 an ounce to a high of $2,070 an ounce – just $5 short of an all-time high reached in August 2020. The bullish momentum also split over into other commodities with Aluminium, Copper, Lithium, Platinum, Palladium, Uranium, Zinc, Coffee, Wheat, and Lumber prices elevated through all-time highs.

U.S Natural Gas prices have almost doubled this quarter and are on course for their strongest rally since 2009. Meanwhile, European Natural Gas prices have skyrocketed 90% to post their biggest monthly rise ever. In total, 27 Commodities ranging from the metals, energies to soft commodities have tallied up double to triple digit gains within the first quarter of 2022 – According to Goldman Sachs “we’re still only at the first inning of a multi-year, potentially decade-long Commodities cycle.”

Agriculture commodities

Food prices have been rising worldwide and are not expected to begin easing until 2023. The World Bank has noted that food prices have now been rising for two years and as of April 2022 were 78% above their average between 2015 and 2019. The Russian invasion of Ukraine has added additional pressure to food markets which were already under strain due to successive poor seasons in major producers. Another underlying driver of food inflation is energy prices, which in turn have led to higher fertiliser prices. Sanctions on Russia are also making an indirect contribution to food prices through higher energy costs. This is causing more widespread price rises for food than seen in the 2008 food price crisis which was more limited to grains and oilseeds. A combination of continued poor seasonal conditions and higher input costs is reducing production prospects worldwide and means the ratio of food supply to demand is likely to fall to its lowest level in 8 years (for the 12 most important agricultural commodities). The policy response to higher food prices by many countries has been to restrict trade – repeating the same mistakes made in the 2008 food price crisis. Trade restrictions shift the burden of higher prices onto fewer people and are felt most acutely by those on the lowest incomes. This increases global food insecurity and is most significant in developing countries, where governments often have less fiscal ability to fund relief programs.

According to the International Food Policy Research Institute’s food export restrictions tracker, the share of globally traded calories now subject to trade restrictions is markedly higher than the 2008 crisis, despite roughly the same number of countries imposing restrictions. By the end of May, 17% of globally traded calories were subject to some form of restriction. The WTO is scheduled to meet in June and has issued a call for members to focus on this issue. Export restrictions are just one of many policy responses which may work against global food security in the longer term. Interventions in domestic production such as the extension or introduction of producer supports, interventions in the markets for inputs such as fertiliser, and the introduction of more onerous trade rules all present longer-term risks.

Gold

Gold prices have been in recovery mode. This seems to go along with several other risk-sensitive themes, such as stocks clawing back prior losses. And, if you take all of this with context of the bigger-picture, it makes sense that what we’ve seen so far is corrective pullback and not necessarily trend-changing. Both stocks and Gold had become quite oversold last month and the pressure points that were driving the move saw some element of calm as there wasn’t major focus on Central Banks and a lessened level of focus on inflation.

However, those data points are coming back into the headlines as we have Central Bank rate decisions from Europe and Australia to go along with inflation data out of China and the United States. Which then of course, brings the FOMC into the mix for the June rate decision which as widely expected was a hike by 75 basis points. More pressing, however, will be the dot plot matrix where the Fed communicates their plans for the rest of the year. This is where some disagreement still exists, such as we saw with Lael Brainard talking about the September rate decision while markets have baked-in expectations for hikes in both June and July. This week’s economic calendar is loaded with risk events pertinent to the inflation picture, with U.S. CPI released at 8.6 per cent. Each of these high-impact events can bring volatility to gold markets.

WTIS

We continue to see historically high energy prices because of the economic recovery and the repercussions of Russia’s full-scale invasion of Ukraine although we expect the current upward pressure on energy prices to lessen, high energy prices will likely remain prevalent globally this year and next. Crude oil markets have been extraordinarily bullish for quite some time, and it’s likely that will continue to be the case. Demand for crude oil was going to pick up as China reopened, and of course, there are a lot of concerns about inflation, which is typically seen in the energy markets first.

The EU announced plans to cut its Russian oil imports by 90% by the year’s end. Actual price outcomes will largely depend on the degree to which existing sanctions imposed on Russia, any potential future sanctions, and independent corporate actions affect Russia’s oil production or the sale of Russia’s oil in the global market.

Sector 12 Month Forecast Economic and Political Predictions
AUD 72-80c

The median forecast from The Australian Financial Review’s quarterly survey of 33 economists predicts the local currency dollar will appreciate to US76¢ by December

There are many different influences over the local currency, increasing commodity prices appear to be the key driver of the recent rise of the AUD. Prices of commodities like oil, wheat and nickel have soared recently on the back of the war in Europe. This has increased the demand for ‘commodity’ currencies like the AUD, helping it move higher against most major currencies including the USD, Euro and British pound.
Gold Hold

$US1500-/oz- $US1900/oz

 

Gold has historically served as an investment that can add a diversifying component to your portfolio, regardless of whether you are worried about inflation, a declining U.S. dollar, or even protecting your wealth. If your focus is simply diversification, gold is not correlated to stocks, bonds, and real estate.
Commodities BUY

World aluminium demand growth is set to shift up a gear driven by energy transition-related sectors such as transportation and renewable energy from China, the US and Europe.

Prospects for continued recovery in global demand supports a robust outlook for goods exporters for the remainder 2022. Resources, energy, and agricultural exports are predicted to remain strong. A significant number of commodities will enjoy strong demand growth on a 20-year horizon and can be dubbed the ‘Commodities of the Future’ – copper, nickel, aluminium, lithium, cobalt, tin, rare earths, metal scrap and green steel.
Property BUY

Some of these assets are considered necessities, such as healthcare, childcare, and even data centres, which are all relatively well insulated against the cycle.

Valuations have remained buoyant and there are growing expectations rental collections will rise, and we will see improved visibility of earnings. Balance sheets generally look good, with the sector’s average gearing levels at 28%, supporting further growth through acquisitions and development. Earnings forecasts have also been positive amid the improving economic backdrop.
Australian Equities BUY

In periods of slowing growth and rising inflation, value stocks, commodities, and real estate are typically the places to be. Some cash can also help with rebalancing.

We expect it is likely Australia will outperform most Developed Markets this year and next year given strong economic momentum, the nation’s position as a commodity exporter, lower inflation pressures,

Growth is slowing and begins to appear overheated in this phase as inflation climbs higher, and stock prices begin to look high compared to earnings. The best sectors in this phase include energy, utilities, healthcare, and consumer staples.

Bonds Begin to increase duration

Treasuries are looking better value for investors who are looking for a safe haven.

 

Long dated bond yields both in the US and Australia soared over the past couple of months as the scale of the inflation challenge has become clearer. Australian 10 year government bonds have jumped to around 4.00%, about 90bps above US 10 years, and sharply up from a year ago.

We expect Australian 10-year bond yields to consolidate above the 3% mark moving into the second half of the year, before moderating to 2.35% by end 2023.

Cash Rates 2.5%-3.3% Lowe indicated that “normal policy” would see the cash rate rise to 2.5% even though investors were predicting even before this months decision that level would be reached by the end of this year, on the way to 3.3% by May 2023.
Global Markets
America Underweight

The more hawkish Fed is pushing real yields higher, which pressures the high market multiples of growth names and could lead to a correction.

Market volatility is likely to continue throughout much of this year because of the high level of uncertainty.

The number of issues causing inflation will increase, and the markets will soon start to focus on midterm elections.

Europe Neutral

Investors torn between worries of a potential recession and the allure of cheaper valuations.

Eurozone inflation hit an annual 8.1% in May, exceeding expectations, and marking a seventh consecutive record high. investors are closely watching the European Central Bank for hints at the pace and scale of interest rate hikes required to rein in consumer prices.

Concerns are also rising about the impact of high input prices on major corporate earnings.

Japan Accumulate

The Tokyo stock market is expected to maintain its upward momentum for the remainder of 2022 as continued rebounding in corporate earnings will likely offset concerns of inflation.

Valuations remain supportive and compare favourably with other developed markets, and earnings momentum is positive. The Japanese equity market remains attractively valued, according to several measures.

For example, the Japanese equity market trades at a much lower multiple than the US equity market, and a substantial percentage of Japanese equities are trading below book value.

Emerging markets Start Buying

Once a collection of non-investment grade countries, it is now composed of a group of liquid, laggard investment grade markets, with lower credit risk, appealing to value, growth, and yield investors.

Strong global growth should be supportive for EM equities, particularly commodity exporters; however, the economic environment and growth outlook is more bifurcated across emerging market equities than across developed world equities.

That said, we believe investors can be tactical in adding to selected emerging markets across Asia, where we are seeing attractive valuations.

China BUY

Valuations for many companies have moved to historical lows and look even more compelling when we compare them to global peers

Chinese policy seems to have shifted marginally towards stimulative measures. The PBOC cut both its one-year and five-year loan prime rates.

Given the government’s constrained spending in 2021, it has scope for more fiscal stimulus, although is handicapped by the ongoing slowdown in land sales, which is restricting the money local governments can raise to spend on infrastructure.

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