Macro Matters May 2022

(Source: Merlea Macro Matters)

Summary

Global economic prospects have been severely set back, largely because of Russia’s invasion of Ukraine. This crisis unfolds as the global economy has not yet fully recovered from the pandemic. Even before the war, inflation in many countries had been rising due to supply‑demand imbalances and policy support during the pandemic, prompting a tightening of monetary policy.  The latest lockdowns in China could cause new bottlenecks in supply chains. In this context, the war will slow economic growth and increase inflation. Overall economic risks have risen sharply, and policy trade‑offs have become even more challenging. Inflation has become a clear and present danger for many countries. Even prior to the war, it surged on the back of soaring commodity prices and supply‑demand imbalances. Many central banks, such as the Federal Reserve, had already moved toward tightening monetary policy. War‑related disruptions amplify those pressures.

Year-to-Date Change in Yields (Percentage points)

I expect inflation will remain elevated for much longer, In the United States and some European countries, it has reached its highest level in more than 40 years in the context of tight labour markets. The risk is rising that inflation expectations move away from central bank inflation targets, prompting a more aggressive tightening response from policymakers. Furthermore, increases in food and fuel prices may also significantly increase the prospect of social unrest in poorer countries.

Financial stability risks have risen on several fronts, even though so far, no global systemic event affecting financial institutions or markets has materialised. A sudden repricing of risk resulting from an intensification of the war and associated escalation of sanctions may expose, and interact with, some of the vulnerabilities built up during the pandemic, leading to a sharp decline in asset prices.

The war also increases the risk of a more permanent fragmentation of the world economy into geopolitical blocs with distinct technology standards, cross‑border payment systems, and reserve currencies. Growth could slow down further, while inflation could exceed our projections if, for instance, sanctions extend to Russian energy exports.

Bonds

Navigating the post-pandemic recovery, including broken supply chains and labour shortages, was always going to prove a challenge for investors and policymakers. Now that the exit from extreme policies has become a certainty, a more volatile market environment seems likely. I see several areas where this environment is creating significant value for fixed income investors.  The dramatic re-pricing of cash rate expectations globally over the past few months has led to one of the worst bear markets for global bond benchmarks in decades.

The combination of rising risk-free rates and widening credit spreads has meant a double blow for most fixed income investors. While much of the impetus has come from the sharp rise in inflation in the US, and the corresponding hawkish shift from the FOMC, Australian fixed income investors have not been spared. The AusBond Composite index, for example, has recorded negative returns over the past year more than -5%. Only the infamous bond bear market of 1994-95 comes close. And from peak to trough, the current episode has recorded even greater capital losses.

Unlike during other recent economic cycles, bond markets are now expecting an aggressive pace of rate hikes over the next 18 months. Delivering such an aggressive pace of monetary tightening to control inflation and ensure a soft landing will not be an easy task. In fact, there are only very few episodes in history where a soft landing after aggressive hikes has been achieved.

The unexpected resurgence of global inflation has precipitated the bond bear market that many investors have feared. Some of these recent moves have been so rapid that most investors probably haven’t realised how different the fixed income environment looks to just 12 months ago.

While I don’t discount the need for policy settings globally to move quickly to more ‘normal’ levels given the sharp rise in inflation and emerging tightness in labour markets, I do not believe that cash rates in Australia are going to quickly rise above 3%, as currently priced into bond markets, as the chart above illustrates. This makes owning Australian sovereign and/or investment grade corporate bonds a particularly appealing buying opportunity for the medium-term investor. The sharp increase in risk-free rates, coupled with credit spread weakness, has significantly increased the attractiveness of the bond market all-in yields. Not only are asset allocators now being compensated more handsomely for their bonds, but the bond market’s defensive characteristics are likely to be much improved also.

Listed Property

The fallout from the COVID-19 pandemic continues to be a source of uncertainty for the Real Estate sector, but mass vaccinations and relaxed restrictions on public gatherings have reduced investor pessimism. The outlook for office REITs is likely to be uncertain until it becomes clear whether there will be an enduring shift toward remote working—although the recent trend appears to be for most workers to eventually return to the office. Nevertheless, increases in office building inventories are likely to weigh on lease prices and potentially property valuations.

Warehouse/distribution centre demand remains strong, resulting in rising rents. If the economic expansion continues, workers return to offices, and interest rates stay relatively low, the Real Estate sector could do very well. In a generally still-low interest rate environment combined with renewed demand for office and retail space, investors’ search for yield and moderate valuations could be a strong tailwind for the sector. However, this sector is very sensitive to rising interest rates, and historically underperformed most other sectors when long term rates rise.

Low interest rates are positive for funding and make REITs’ traditionally high dividends more attractive to investors. Warehouse, data centre and telecom towers are benefiting from technology and e-commerce trends. Residential REITs segments are seeing strong demand and rising rents, which is translating into further higher rents. Long-term demographics support recovery in extended-care and assisted-living facilities.

Risks for the sector: A quicker-than-expected rise in interest rates could be a sharp headwind, A permanent rise in work-from-home could reduce demand for office real estate.

Key takeaways from the last reporting season include:

  • Valuations remain strong, particularly for industrial, self-storage, and convenient retail.
  • For discretionary retail and the office sector, valuations are bottoming out and improving.
  • Growing expectations of rising rental collections and improved visibility of earnings, particularly for retail REITs given the end of the rental code of conduct in NSW and VIC.
  • Strong balance sheets, with the sector’s average gearing of 27% further supporting growth through acquisitions and developments.
  • An improving economic backdrop of record low unemployment, rising business, and consumer confidence, supporting commercial property market fundamentals, lowering vacancy and fewer rental abatements.
  • Strong earnings forecasts of over 20% for FY22 as retail rebounds from the COVID drag and fund managers such as GMG, CHC, and CNI continue to upgrade earnings.

M and A activity for commercial real estate investment continues to grow, and there is an increasing sense of urgency among large investors to deploy capital efficiently, especially considering a more uncertain medium-term outlook than at the start of 2022. It appears the strong appetite for large portfolio deals is here to stay.

Australian Equities

For months, the RBA governor Philip Lowe has insisted rates would not rise until wages growth kicks into gear. But it’s now widely anticipated the first-rate hike is just around the corner, possibly as early as 3rd of May / June, placing the RBA between the rock and the very hard place it desperately was hoping to avoid. Australian 10-year bond yields jumped by 80bps to 3.08% in March as markets priced in faster rate hikes both internationally and locally. U.S. 10-year yields rose by a more modest 49%. Surging yields meant that government bonds recorded one of their worst quarters in many years. The Australian bond index fell by 6.3% and the U.S. bond index by 5.6% in local currency terms.

The unemployment rate fell to 4.0% in February, a level not experienced since prior to the global financial crisis in 2008. Employment jumped by 77,000 and was the biggest monthly gain since November of 2021. This means that total employment is close to 3%, higher than pre-COVID-19 levels. The unemployment rate is now near the RBA’s estimate of full employment.

The official measure of base pay rates shows they are growing at their fastest pace since the pandemic started, but wages growth varies wildly by industry and occupation and average pay increases are still trailing the rising cost of living. Prices have shot up ahead of wage growth and this has coincided with the government’s consumer and business stimulus being removed from the economy and the beginning of a period of rising interest rates. And whether this strong labour market will remain long enough to garner wage growth remains to be seen.

House prices fell in Melbourne and Sydney in March compared to the prior month, but the strength in smaller capital cities lifted the combined capital price rise by 0.3% month-over-month. Compared to a year ago, national prices rose by 18.2%, falling below the 20% growth rate for the first time in six months.

While consumer confidence dipped 4.2% for March, the February business confidence rebounded after a January dip. This likely reflects the receding Omicron wave companies faced in January.

History tells us the market takes a pragmatic view on elections. While these times throw up uncertainties, investors can look beyond the campaign slogans. This is no better evidenced by the 1.8 per cent rise in the market in the lead-up to the 2019 election, despite the opinion polls at the time pointing to a Labour victory on its agenda of tax equalisation and investment reform.

On average the All Ordinaries performs well in both the lead-up to and after an election. In the 14 elections since 1983, the average return of the market during the five-week campaign leading to election day is 1.74 per cent. After the results are completed, the average returns of the All Ordinaries were 4.41 per cent for the three months post-election day as the afterglow of a regenerated government filled with stimulatory promises lifts the spirits of both businesses and consumers.

Australian shares could continue to outperform those in the US given that inflation is also higher in the US than in Australia, with the local Consumer Price Index sitting at 5.1% in the first quarter of 2022. In addition, the nation’s largest companies are the big miners and other ‘value’ shares which are relatively more resilient to inflation and higher bond yields.

Global markets

America

The Fed’s plans to tighten policy seem credible, even at the cost of weakening growth. FOMC members feel burned after the Fed’s professional forecasters woefully underestimated the intensity of inflation in late 2021 and early 2022. Their forecasts assumed that supply-side bottlenecks pushing up inflation—supply chain turmoil, low labour force participation, chip shortages—would ease by late 2021 and bring inflation down. But they haven’t, and inflation hasn’t either.

Chair Powell now says the FOMC “will be looking to actual progress on [resolving economic bottlenecks] and not assuming significant near-term supply-side relief.” A more data-dependent monetary policy means faster tightening since the data show so much inflation—and inflation will get worse before it gets better due to the Russia-Ukraine shock and renewed lockdowns in China.

The Fed is also concerned that labour demand is outstripping supply. The sum of job openings and current employment is up by 3 million since early 2020, while the labour force is roughly unchanged.  Considering this, economist now forecast the Fed to raise the federal funds target by a half percentage point at their next two decisions in May and June, and by a quarter percentage point at the July, September, and December decisions. The forecast anticipates two more quarter-percentage-point hikes in the first half of 2023. By the second half of 2023, that would put the federal funds target above its peak in the last expansion, when higher interest rates contributed to a drop in residential investment, industrial production, and job openings—in other words, restricted economic growth.

Longer-term interest rates are likely to rise less than short-term rates. This is despite the Fed beginning to unwind purchases of government-backed securities made during the pandemic, a.k.a. QE. Beginning at the May FOMC meeting, the Fed will probably start reducing bond holdings by accepting repayment on a portion of the maturing bonds. As the Fed reduces bond holdings, the Treasury will need private investors to buy more government bonds to roll over the federal debt and finance new borrowings. All things equal, more bond supply tends to push bond prices lower and bond yields higher. But, while monetary policy will be pushing longer-term interest rates up, the business cycle will be pushing them down.

Economic growth will slow as inflation eats into consumer spending power and businesses finish rebuilding inventories. Oil prices will likely stabilise once the Russia-Ukraine conflict cools. As economic growth slows and commodity prices come back down, wage growth and inflation should cool as well. These factors are likely to mostly offset the Fed reducing the size of its bond holdings, limiting the rise of longer-term interest rates.

Europe

Geopolitical scares typically produce very short-lived market disruptions, with commodities and risk assets quick to recover. The standoff between Russia and Ukraine could be different. If Russia goes big, it could quickly subdue Kyiv, the nation’s capital, oust the democratically elected government and return the country to de facto Russian rule. Ukraine is a former Soviet republic that has been independent since the USSR dissolved in 1991 and is increasingly aligned with the West. Putin wants to turn back the clock and restore some of the old USSR’s territorial and political dominance, and Ukraine is the main target. The humanitarian catastrophe in Ukraine is reverberating across Europe. Some 5 million refugees have already fled the fighting in the largest exodus the continent has seen since the Second World War.

The greatest numbers of flowed across borders to Poland, Romania, Hungary, and Moldova. The war is a serious setback to Europe’s strong, yet incomplete, recovery from the pandemic. It left private consumption and investment well-below pre-coronavirus forecasts, even as fiscal and monetary support underpinned an impressive rebound in employment almost to the levels last seen before the pandemic.

The war is a supply shock that reduces economic output and raises prices. Indeed, the IMF forecast inflation will accelerate to 5.5 percent in advance economies, and to 9 percent in emerging European economies, excluding Belarus, Russia, Turkey, and Ukraine. Spiking energy and food prices are now cutting into household consumption and foreign profits, while economic uncertainty is poised to restrain investment.  The war is a reminder, too, of how Europe must do more to improve energy security, notably, by expanding renewed resources and improving efficiency.

Of course, it’s also important to acknowledge the influence of inflation throughout the IPO market also. The interest rate increases that have followed record-breaking rises in inflation have put considerable pressure on stock prices.

Due to fears over market volatility, many IPOs are beginning to get shelved by businesses unwilling to risk an underwhelming debut. The prospect of interest rate hikes along with slower economic growth and geopolitical concerns have impacted global equities heavily – putting them on a collision course with the worst month since the beginning of the pandemic. Most notably, tech and growth stocks have been heavily impacted by the downturn, with investors selling off in order to buy into cheaper stocks.

United Kingdom

Cost of living crisis, inflationary pressures and uncertainty about Ukraine mean the UK’s pandemic rebound is running out of steam. Company directors fear the cost-of-living crisis and tumbling consumer confidence will cause greater harm than previously estimated, increasing the risk of an economic downturn this year, according to a major new study by Institute of Directors (IoD). A measure of business-leader optimism in the economy, the directors’ economic confidence index fell to -36 in April from -4 in February.

Shortages of staff across industries such as IT, manufacturing, construction, and hospitality are also forcing employers to pay signing-on fees, bonuses, and higher wages to secure employees with the necessary skills. Meanwhile, the number of workers on payroll increased by 108,000 to a record of 29.5 million in January. The unemployment rate decreased to 4.1% in the final three months of last year. Labour shortages across all sectors continued to squeeze the market, with the number of open positions rising to a record level of almost 1.3 million in the three months to January. Average weekly wages, including bonuses, grew 4.3% in the final quarter of 2021.

The Bank of England is expected to increase interest rates in response to a jump in inflation to 7% in March, adding further pressure on indebted businesses and households that rely on credit to make ends meet.  Officials at the central bank will publish their latest forecasts for the economy, which are likely to show it contracting in the second quarter in response to a decline in household spending power.

Japan

Escalation of the Ukraine conflict poses significant downside risks to the Japanese economy through commodity prices, financial and trade spill overs, supply-chain disruptions and other factors. Japanese authorities reaffirmed that the recovery of the world’s third largest economy from the downturn triggered by the coronavirus pandemic is expected to continue this year, through strong fiscal policy support and steady progress in the rollout of COVID-19 vaccines.

The yield on the 10-year Japanese government bond rose to as high as 0.25% in early trade to touch the upper limit of the central bank’s yield target. The Bank of Japan said on Wednesday it has decided to offer to buy an unlimited amount of 10-year Japanese government bonds (JGB) at 0.25%, in its third move to defend its yield target since February.

The rise in yields comes as the yen weakens sharply to two-decade lows against the U.S. dollar, forcing markets to test the central bank’s commitment to its super easy yield-curve-control policy. With the economy still weak and inflation modest compared with Western economies, the BOJ has stressed its resolve to keep monetary policy ultra-loose even as the U.S. Federal Reserve is set to raise rates to stem soaring inflation. It remains to be seen just how long the BOJ can continue to defend the ‘line in the sand’ for the bond market, whereby it has effectively capped 10 year yields on 10 year bonds to below 0.25%. “Something has gotta give.” I believe the BOJ will soon have to let the yield rise on the 10 year to support the yen. If this outcome eventuates, it could prove explosive for Japanese financials

China

The latest Omicron wave poses significant challenges to the Chinese economy. The economic costs of lockdown measures are higher than in previous outbreaks, weighing on production as well as consumption. Tight nationwide travel restrictions are causing domestic logistics bottlenecks. Road freight flow, more than 70% of China’s overall freight traffic, fell by more than 25% year-over-year in early April. We expect China to maintain its zero-COVID policy in the near term and Omicron’s high infectiousness raises the risk of further lockdowns even after the current wave fades.  Additionally, China’s property sector data continued to slow in March. High-frequency indicators, especially home sales volume, point to continued weakness in April. We see a rising risk of a more persistent property downturn: a decline in new home prices in lower-tier cities may cause more prospective home buyers to take a “wait and see” approach.

Policy stimulus and vaccine rollout offer hope

Facing economic pressures from the Omicron outbreak, as well as weakness in the property sector, we expect Chinese policymakers to step up policy easing to support growth. Monetary, fiscal and property sector easing measures that were recently announced have not yet offset the fallout from tighter COVID-19 restrictions.  But further easing through reserve requirement ratio (RRR) or policy rate cuts will likely be limited. That’s because policymakers will look to protect banks’ net interest rate margins as well as the interest rate differential between China and major DM economies. Rather, we think monetary easing will likely be focused more on boosting credit growth through relending and window guidance (an informal mechanism by which a central bank guides a bank to issue loans).

Early signals of plans to ease China’s zero-COVID policy in Hong Kong, together with higher vaccination rates and further stimulus may be enough to reassure markets as soon as June.

The surveillance pictures were mostly taken between June and December last year. Photograph: Inquirer.net/Philippine Daily InquirerBeijing has been accused of building “island fortresses” in the South China Sea after a newspaper in the Philippines obtained aerial photographs offering what experts called the most detailed glimpse yet of China’s militarisation of the waterway.

I have real concerns that Chinese leader Xi Jinping will take lessons from Putin’s high-risk military posturing.  And I believe we should expect that Xi will redouble the Chinese Communist Party’s attempts to assert its control over Taiwan and its longer-term goal for strategic dominance in Asia. China and Russia have become increasingly close since the Russian takeover of Crimea in 2014 and Beijing’s annexation of much of the South China Sea by island building to establish military bases in the same year. Xi is copying Putin’s international playbook. Both leaders take big international risks—consider Russia’s military intervention in Syria and China’s authoritarian crackdown in Hong Kong—both have championed vast and rapid military build-ups, and both threaten the use of military force to press for Western acquiescence.

Emerging markets

Downside momentum in EM equities may have already begun to stall. Over 2021 EM equities underperformed their DM counterparts by 24.5%, while year-to-date the underperformance is just 3.5%. Encouragingly, the relative earnings revision ratio for EM equities appears to have bottomed. So far in 2022, DM indices have been “catching down” to EM indices, rather than EM stocks staging any sort of recovery. Much of the weakness in global stocks comes from repricing for slower global growth as well as discounting for higher interest rates. A better global growth picture is a necessary but probably insufficient condition for EM equities to start outperforming DM equities. I remain more optimistic than some about the state of global growth: while global economic data have dipped, neither the level of activity, nor the strength in labour markets, is consistent with imminent recession.

As a result, and as we approach mid-year, we see scope for the EM outlook to become more favourable. Further policy stimulus from China, combined with evidence of a successful vaccine booster program that would pave the way for easing COVID-19 restrictions, should be important steps. Equally, sustained goods demand and avoiding a further deterioration in supply chains could lend support to other key EM Asian regions. Finally, if the U.S. is indeed past the peak in year-over-year inflation prints then the USD could give back some of its early year strength.

Commodities

Investors have pointed to long-term underinvestment in traditional energy sources, relatively new inflationary pressures, as well as Russia’s war in Ukraine for their reawakened interest in energy and commodity stocks. But can these miners, producers and explorers continue to trade at elevated prices for longer than we think?

Interestingly, there have only been four “commodity supercycles” since the 19th century. The most recent started in the 2000s as China began to rapidly industrialise and modernise its economy. While this supercycle was briefly interrupted by the Global Financial Crisis, the bubble didn’t truly pop until 2014, when oil peaked at US$107.95 a barrel (for some context, today, crude oil prices are trading around US$103.38 a barrel. See chart below):

We’re probably unlikely to see the super boom that we saw in the 2000s. Remember those years were underpinned by incredible demand out of an emerging Asia, where they were building lots of roads and infrastructure. And the world was really going through an incredibly strong pickup in activity, and it was demand-led. Right now, the disruption that’s taking place, whether it’s caused by COVID related restrictions in some countries or whether it’s due to the current conflict in Ukraine, all of that together has meant commodity prices have been incredibly high and resources companies are really going through an incredible boom period in terms of the earnings that they generate.

Agriculture commodities

Global food commodity prices hit an all-time high in March following Russia’s invasion of Ukraine, according to the UN Food and Agriculture Organization (FAO).  Alongside the continuing humanitarian crisis, the conflict has destabilised Ukraine’s economy, with the World Bank predicting a more than 45% fall in economic output in 2022.

The Russian Federation and Ukraine, combined, supply around 30% of global wheat exports and around a fifth of the world’s maize. Shortages of these and other commodities have destabilised global supply chains, sending food prices soaring. Higher global food prices are part of a wider trend of cost of living increases already at work in both advanced and emerging economies, exacerbated by Russia’s invasion of Ukraine. The FAO Food Price Index measures the monthly change in global prices of a basket of food commodities. Figures for March show a 12.6% increase in global food prices compared to February, the highest price levels recorded in the index’s three-decade history. Year-on-year comparisons show index prices increased by a third compared to March 2021.

The global economy is still some way off a recovery, following the economic impact of the COVID-19 pandemic. Rising inflation, supply-chain disruptions – that are yet to return to pre-pandemic ‘normal’ levels – and other post-lockdown hangovers have caused prices to increase, for everything from food to energy bills.

While the squeeze on household incomes is an unwelcome visitor to most homes, low-income families in developing countries will be worst affected. For the developing world, higher prices go hand in hand with greater food insecurity as reduced exports of cereals and other commodities pose the greatest threat for these regions.  But, despite the impact on food exports due to the war in Ukraine, the FAO Cereal Supply and Demand Brief forecasts global wheat production in 2022 will reach 784 million tonnes, a 1.1% increase from the previous year. This is due to favourable production trends in regions like China, India, North America, and the European Union, which could help stabilise global markets and provide food security to those who need it most.

Gold

Geopolitical concerns have not gone far away, after Russian foreign affairs minister Sergei Lavrov’s warning about the risk of a nuclear war, and after explosions were detected in Moldova’s Russian enclave of Transnistria, on the western border with Ukraine. Prices for gold and other precious metals have rallied as investors have rebalanced their portfolios towards safe-haven assets. The Russian central bank said it would resume its purchases of gold after a two-year pause, as the international community imposed a fresh round of sanctions targeting the banking system. The pause in the rally suggested that a fair amount of risk premium had already been priced in. Elevated inflation is pushing real rates further into negative territory, which broadly protects the downside for gold in the short term. Nevertheless, this could be offset by aggressive rate hikes by the Fed.

In times of market volatility, gold tends to be a safe investment and a desirable asset for investors. During periods of high inflation, like the pandemic-induced one we are living in right now, gold has been seen as a safe bet to guard against rising prices and unpredictable stock markets, as the asset has a history of delivering higher-than-inflation returns.

Gold’s traditional status may explain the current surge in trading activity, but gold’s rate of growth relative to inflation has slowed in recent years, diminishing its role as a long-term hedge.

WTIS

A lower-for-longer oil price environment has taken a toll on the capital spending of exploration and production (E&P) companies. Actual and announced capex cuts have gone below the minimum required levels to offset depletion, let alone meet any expected growth. Underinvestment always precedes the next commodity cycle and the chart below shows that capital investments in major integrated oil and gas companies declined by 52% between 2013 and 2020. Capital expenditure in the copper industry declined by 44% between 2012 and 2020.

The only thing that can stimulate investment in these sectors is an increase in the price. If even half of the expected demand comes through, then supply will prove to be insufficient, which will push prices higher and stimulate investment. How much new oil supply does the world need? A lot I would suspect. The war in Ukraine has caused major supply disruptions and led to historically higher prices for several commodities. The price of Brent crude oil is projected to average $100/bbl in 2022, a 42 percent increase from 2021 and its highest level since 2013.

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

 

Economists predict elevated energy prices amid a devastating war in Ukraine, the prospect of higher interest rates and strong global growth will underpin the Australian dollar in 2022, propelling it to its highest level since June 2021
Gold Hold

$US1500-/oz- $US1900/oz

 

Gold’s traditional status may explain the current surge in trading activity, but gold’s rate of growth relative to inflation has slowed in recent years, diminishing its role as a long-term hedge.

Today, the demand for gold, the amount of gold in the central bank reserves, the value of the U.S. dollar, and the desire to hold gold as a hedge against inflation and currency devaluation, all help drive the price of the precious metal

Commodities Buy

The aluminium market is heading into a period of structural deficits and there is no quick fix to resolve this; this should see prices trading higher.

A significant number of commodities will enjoy strong demand growth on a 20-year horizon and can be dubbed the ‘Commodities of the Future’. They are copper, nickel, aluminium, lithium, cobalt, tin, rare earths, metal scrap and green steel.
Property Buy REITs provide reasonable protection against inflation because rents are not as sticky as other prices. Long term leases typically have inflation protection built-in, and shorter-term leases are based on current price levels. Finally, as owners of real assets, REITs typically enjoy an appreciation in portfolio value along with the price level.
Australian Equities Buy We retain a preference for Australia over global equities on a 6–12-month view. Australia’s recent sell-off is looking overdone in a relativity sense. Australia has a lower tech exposure and should offer more “valuation” protection from rising rates via its large financials and resources exposure.
Bonds Begin to increase duration

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

 

Australian government bonds appear attractive to long-term investors because of rapid interest rate hikes for the central bank to go too far in market pricing. Most of the expected increase is already priced into markets. Yields on 10-year Australia notes rose to a two-year high of 2.13% in April as investors bet on rate hikes.
Cash Rates 0.1 – 1.5% Australian interest rates are tipped to hit as high as 1.5 per cent by the middle of next year as the nation’s central bank moves to put a cap on soaring inflation.
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

Ahead of the Fed raising rates, equity market investors appear to be moving from growth stocks into value stocks and could also see small-cap stocks suffer, U.S. banks are set to benefit from higher rates. Some forecasters are predicting the Federal Reserve will increase interest rates five, six or even seven times over the course of 2022.
Europe Neutral

European markets are already pricing chunky geopolitical risks, but there is scope for risk premia to rise further across all sectors.

European equities ended March down as higher inflation, the US Fed’s hawkish shift, and the Russian conflict weighed on European stocks. While valuation gaps within sectors have narrowed slightly in January, they are still at extended levels and nowhere near long-term norms.
Japan Accumulate

Japanese stocks fell in January amid rising concerns over the outlook for interest rate hikes, quantitative monetary tightening in the US and a rapid increase in the number of domestic Covid cases.

Valuations remain supportive and compare favourably with other developed markets, and earnings momentum is positive. However, the unwinding of global monetary easing will accentuate the importance of bottom-up stock picking, particularly in identifying companies that can grow earnings over the mid-term.
Emerging markets Start Buying 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 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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