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The two T’s

INVESTMENT

9 June 2021

 

The prospect of tapering, and exactly how transitory inflationary pressures will be, has dominated market discussions recently. Our Chief Investment Office provide their view.

Our view

While the gradual reopening of the global economy continues to define the broader economic and market backdrop, investors are increasingly turning their attention to other drivers of sentiment. It is two T words in particular - transitory and tapering - which are shaping the current mood of financial markets.

Increasing global CPI inflation prints were broadly anticipated due to year-on-year base effects stemming from last year’s slump in growth and inflation numbers. Up until recently though, investors expected this to be transitory. Most notable was the U.S. 4.2% year-on-year CPI print released in May. This level had not been seen for more than a decade and resulted in sharp ruptures in equity and bond markets.

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US CPI INFLATION POP

 

Source: BCA Research, May 2021

However, the last few months have also seen a broadening of inflationary pressures, resulting from disruptions to supply chains. The increasing belief from investors that inflationary pressures might be more permanent than initially thought brings us to the next factor - tapering. Arguments aside about whether central banks should taper or not (for the record we believe it is unlikely to be messaged until late 2021), can the so widely forecast and feared “taper tantrum 2021” be a risk at all? Or is it not all already priced in?

Despite investor concerns, we don’t believe now is the appropriate time to adjust our mild overweight to risk assets. Central bank liquidity remains abundant and macroeconomic tailwinds are favourable for equities. As we correctly expected last month, the earnings season was exceptionally strong in the context of its history, and has turned out to be mildly positive for equities. However, as the debate surrounding tapering and the transitory (or non-transitory) nature of inflation plays out, some of the more expensive and interest rate sensitive segments within equities have started to witness increased selling pressure. Most notable has been large cap tech names, which are long duration assets by nature, and are likely to see high levels of volatility going forward, as inflation fears fester.

What this means for our diversified portfolios

Our positioning from last month has not changed.

We retain our mild overweight to growth assets, expressed via mildly overweight positions in global developed markets and emerging markets equities. While we still believe the domestic share market is positioned for further gains this year, there are better relative opportunities abroad.

Our mild underweight to defensive assets has been constructed with an underweight position to cash and neutral positioning in global and domestic bonds. We continue to favour duration and the additional yield pick-up on offer, relative to cash.

ANZ investment strategy positions – June

Investment position
Asset class Reasoning

Growth Assets

Developed market equities

Developed market equities remain our preferred exposure to growth assets and we hold our mild overweight position to the asset class this month.

The recent U.S. reporting season was exceptionally strong, and this in turn was a mildly positive impetus for asset prices. However, we believe some of the more expensive and interest rate sensitive segments within equities, in particular large cap tech names, are likely to see higher levels of volatility owing to their long duration nature, and the market’s concerns surrounding inflation.

We seek to maintain a somewhat balanced approach between market segments within the portfolio, with the U.S, Europe and Japan all offering different characteristics for portfolios.

Australian equities

We remain positive on the broader outlook for Australian shares. However, portfolios already hold a high strategic allocation to the domestic share market and we believe global developed markets, in particular those with a higher exposure to ‘quality’ stocks in healthcare, telecommunications and renewable energy sectors are more likely to outperform in the near-to-medium term. We maintain a neutral allocation to the local share market accordingly.

Emerging-market equities

We are mildly overweight to emerging markets (EM) equities. The recent underperformance of the asset class provides us with increased optimism for some near-term relative outperformance. EM equities remain the most attractive equity region in terms of a 12-month return upside, particularly when compared to developed markets where we see more limited upside over that timeframe. 

Global REITs

We currently hold a mild underweight to listed real assets, owing to our below benchmark position in listed infrastructure. We remain benchmark in global REITs (GREITs) after trimming the position last month. We are still constructive on the outlook for GREITs and they remain a critical part of portfolios given their dividend yield, diversifying effect for multi asset portfolios and ability to act as an inflation hedge. However, increased valuations have meant we now see better relative opportunities elsewhere in growth assets.

Similar to previous months we maintain our current view on listed infrastructure. Namely, better opportunities to invest in the asset class may arise in the future given the ‘lower for longer’ rates scenario and potential for further fiscal support via infrastructure spending. Until such time we have a bias towards GREITs and preference for equities.

Alternative growth

We advocate a long-term strategic allocation to alternative risk and return drivers in order 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.

Foreign Exchange Hedge Ratio*

Within portfolios we maintain our benchmark position to the Australian dollar (AUD) hedge ratio for global equities, which is now sitting at approximately 28%. This position remains with a view to providing downside risk protection in the event of a risk-off environment.

Defensive Assets

International fixed income

Our base case remains that bond yields are likely to tread sideways in the near-term, with a skew to mildly higher yields. We watch for slightly higher yields in order to consider extending duration positioning and remain neutral in global fixed income for the time being. We currently see better opportunities in credit over sovereigns given monetary policy support, the hunt for yield and broader economic prospects.

 

Notes:

*Percentage of developed market and emerging market equities hedged from foreign currency into Australian dollars.

Tactical Asset Allocation is current as at 1 June 2021

 

To discuss what this insight could mean for you, or for a copy of our full investment update, talk to your ANZ Private Banker directly, or contact us below.

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