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Amidst inflation jitters focus remains on re-openings and vaccine roll-outs

 

15 March 2021

House view

 

 

Is the sell-off in bond markets an overreaction? Find out more as the ANZ Chief Investment Office explains recent market developments.

Global markets went into meltdown in February amid expectations that inflation is making a comeback. Investors and market participants were in a frenzy as to when and how quickly inflation will return.

While the encouraging signs of global economic re-openings and the potential massive fiscal stimulus have been welcomed in some sectors, government bond markets saw massive sell-offs.

However, ANZ’s Chief Investment Office says while near-term inflation may rise further from its current levels, it doesn’t expect inflation to materialise in a sustained manner until at least 2022.

In the meantime, financial markets and central banks appear to be at a stand-off as to who will blink first. Global central banks have maintained their commitment to loose monetary policy in the near-term.

Given this supportive policy direction, we view the current concerns surrounding rising rates as overstated — particularly given unemployment levels remain below their pre-pandemic peak and outputs gaps exist globally.

Despite the recent volatility, equities have continued to outperform. And while valuations remain challenging, markets have been buoyed by growth prospects on the back of successful vaccination roll-outs and falling COVID-19 infection rates.

Within the equity market, we see a continued outperformance of ‘value’ stocks in the short term, as the re-opening of economies supports cyclical industries which were suppressed by COVID restrictions.

‘Growth’ stocks are typically driven by longer-term dynamics, making them more sensitive to a higher discount rate. Put simply, if rates rise, growth stocks are typically hit hardest.

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Investment outlook in brief

While the rise in bond yields has caused nervousness in some market segments, we believe the risk of inflationary pressure is overstated and that markets should continue to be supported by the growth story as more economies re-open. As such, we have increased our exposure to growth assets.

Given our view that ‘value’ should outperform in the near-term, we have taken emerging market equities overweight. The asset class is highly cyclical and should continue to benefit from the reopening trade and a weakening US dollar.

ANZ investment strategy positions - March

Investment position
Asset class Reasoning
Growth Assets

We have increased our overweight position to growth assets via purchases in emerging market equities and listed real assets via GREITs.

We maintain an overweight to developed markets and Australian shares.

We see emerging markets benefiting from the re-opening of global economies.

And while GREITs significantly underperformed global shares during the pandemic, they are appealing on a valuations basis and in the short-term at least, should benefit further from re-opening trade.

Developed market equities

We expect equities to continue to outperform cash and fixed income over the course of 2021. But it will not be a linear pathway for the asset class and we expect volatility to remain in the near-term.

We continue to favour the US amongst the major developed markets due to its quality/growth characteristics. While we favour ‘value’ in the near-term we expect ‘growth’ to marginally outperform over 2021.

We have upgraded European equities within our developed market scoring. Despite their stretched valuations, their cyclical exposure looks appealing in the short-term.

Australian equities

We retain our mild overweight position to the asset class. Given the highly cyclical nature of Australian equities, the position is expected to provide exposure to this segment of the market, which is expected to outperform in the short-to-medium term. Longer-term we see more favourable opportunities in other developed markets.

Emerging-market equities

Given the potential for cyclicals to outperform in the short-term, we have increased our exposure to EM taking portfolios to overweight from neutral.

This asset class also offers favourable sector tilts, with high exposure to Tech and Consumer Services.

Within EM, the Asian region is where we expect to see the most upside.

Listed real assets1

We are now overweight listed real assets.

GREITs remain attractively valued on a relative basis, having significantly underperformed equities during the pandemic.

Should inflationary pressures continue to pick-up in 2021, this sector should provide some protection for portfolios.

We continue to see strategic opportunities in listed infrastructure given the “lower for longer” rates scenario and increased potential for fiscal support via infrastructure spending that a Biden administration brings.

Alternative growth

We maintain a benchmark position on Alternative growth assets as we continue to advocate a long-term strategic allocation to alternative risk and return drivers to provide diversification from equity beta.

This asset class typically has less volatility than equities and is, therefore, a valuable diversifier in periods of extreme markets conditions.

 
Defensive Assets

We are underweight defensive assets.

The positioning is in place due to significant underweight to cash within our portfolios.

Despite the pressure which bonds have come under recently, we expect structural forces to keep yields capped in the medium-term and may seek to build our position here in the months ahead if we believe growth assets have run too far.

International fixed income

While inflation risks have increased since last month, it is the persistence of global output gaps and labour market slack which supports our base case for inflation risks remaining limited within the forecast horizon – and most likely for some time after. Coupled with accommodative central bank policy, nominal yields should remain low and many real rates in negative territory, ensuring the economic recovery and rising levels of fiscal debt can be sustained for a prolonged period.  We remain overweight international fixed income for the time-being as a result. Our position holds decent exposure to credit (which has held up relatively well) in which see the potential for further upside.

Australian fixed income

We are overweight Australian fixed income.  ‘Aussie’ rates look attractive on many metrics and have the second most room to zero in the Developed Markets rates space. We like Aussie duration as an addition to the U.S. duration position. This position is due to the additional yield pick-up, relative to cash, from the asset class.

Cash

We are underweight this asset class, preferring the relatively low-risk yield pick-up afforded by fixed income at current levels.

Currency
Foreign currency hedge ratio2

We are at benchmark weight for the Australian dollar. The AUD appreciated strongly in 2020 and has started 2021 with reasonable volatility reaching as high as USD 0.82 in February before retracing late in the month.

There is still potential for further upside before the year finishes, particularly if ‘TINA’ and stronger commodity prices eventuate.

Despite this, the AUD is a risk currency and we remain close to benchmark at this stage as a defensive hedge.

Notes:

1. Comprises of 50/50 split between GREITs and infrastructure securities.
2. Percentage of developed market and emerging market equities hedged from foreign currency into Australian dollars.
Representative diversified portfolio with 70/30 growth/defensive assets.
As at 4 March 2021.

 

Read the full Chief Investment Officer House View (PDF 617kB)

 

 

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