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Upside limits and the potential for volatility


14 July 2021

House view





As the globe continues to reopen for business, our Chief Investment Office has further reduced their exposure to risk assets, leaving portfolios only mildly overweight to growth. Find out why.

Our view

Over the past six months’ market participants have focused on the prospects of a return to normality and the associated reopening of economies that would accompany this. Our domestic predicament aside, with an increasing number of people inoculated worldwide, and travel restrictions being wound back across significant parts of the globe, it appears we may finally be getting to the point of this actually happening - London is currently playing host to Wimbledon and Japan appears ready to light the cauldron of the XXXII Olympiad.

In financial markets it’s often more important to be invested on the expectation of something and then move on if and when the expectation materialises. So if the global economy is officially back open for business (well, sort of), then what next? Batten down the hatches and turn to capital preservation mode? No, it’s still too early for this. However, we believe the potential upside for equity markets and pace at which they may climb from here should be limited.

As mentioned last month financial markets are still faced with the two ugly T’s. The first T has to do with inflation, or more specifically the transitory nature of it. The second T being the Federal Reserve (the Fed) tapering. Both now appear to be taking effect.

Transitory effects are kicking in and inflationary pressures are gradually abating. In some cases, the retrenchment of inflationary pressures has happened quite fast so the inflation pandemonium of the past few months has actually been more speculative than anything. Nonetheless, it has also transpired that there is, at least for the time being, some degree of stickiness in the inflation data.

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US inflation overshoot expected to be temporary

Graph showing US inflation overshoot

Sources: Bloomberg Finance L.P, DWS Investment GmbH, as at June 2021.  Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.

Which takes us to the next T – tapering. Currently investors are pricing in such an aggressive pace of tapering that one can only deduce that the market is questioning the Fed’s new Flexible Average Inflation Targeting Framework (FAIT) which explicitly allows for temporary over and undershooting of CPI prints. Given current market expectations and assuming the Fed doesn’t abandon its new framework, it is difficult to see how it is even remotely able to deliver such a hawkish narrative around tapering.

So despite remaining front of mind for market participants, we now harbour less concern about the two T’s than we did previously. To be clear they remain risks, but perhaps we can now remove the capitalisation and instead refer to them as the two t’s. Given this, investors could even find themselves in a scenario where the withdrawal of monetary stimulus potentially becomes a dovish surprise, and equity markets “awash with ample liquidity” grind higher.

What this means for our diversified portfolios

Midway through last quarter we reduced our mild overweight to growth assets, electing to take some profits, in recognition of our belief that any moves higher for equity markets are unlikely to be as strong as the previous twelve months. This has proven correct so far, and while there is still scope for equities to grind higher from here, we are conscious of protecting the downside for our portfolios and locking in some of the gains achieved from being overweight growth assets.

While we remain mildly overweight growth assets, any pathway for further gains is likely to be limited and equity markets are expected to be more volatile than in previous quarters. As such, we have further reduced our exposure to growth assets this month by clipping emerging markets in our more aggressive growth portfolios and developed markets equities in those less aggressive portfolios. Proceeds have been placed into cash.

ANZ investment strategy positions - July

Investment position
Asset class Reasoning
Growth Assets


Developed market equities

Our portfolios remain mildly overweight developed market equities. Despite trimming our allocation to the asset class in some portfolios this month it remains our preferred exposure within growth assets.

Considering investment styles within global developed markets we believe ‘quality’ and ‘cyclical’ stocks are likely to outperform ‘momentum’ in the near-term and some sectors including healthcare could be beneficiaries. We have recently upgraded the Eurozone and U.K in our scoring model and believe there is a greater likelihood of short-term outperformance from the region vs. the United States.

However, at this juncture we prefer to keep a somewhat balanced approach between market segments within the portfolio, with quality/growth represented by the U.S and cyclical/value exposure via Europe and Japan.

Australian equities

Our outlook for Australian shares has not changed since last month and we remain at benchmark to the asset class.

Despite almost nationwide lockdowns recently, we are still positive on the broader outlook for Australian shares. However, portfolios already hold a high strategic allocation to the domestic share market and with approximately 50% of the ASX 300 comprised of materials and financials stocks, we believe global developed markets — in particular those with a higher exposure to ‘quality’ sectors like Healthcare — offer greater diversification and are more likely to outperform in the near-to-medium term.

Emerging-market equities

Emerging markets (EM) shares lagged their developed market peers by 1.4% in June, finishing a disappointing quarter for the asset class which underperformed the MSCI World ex Australia (unhedged) by 2.7% during the period. China, which accounts for almost 40% of the index was the biggest laggard, finishing the quarter only 1.4% higher, dragging on the broader index in the process.

Our previous preference for EM and strong conviction for near-term outperformance, has been tempered somewhat and we believe those sections of the market with a stronger quality bias are more likely to outperform in the short-term. As such, we have shifted from a mild overweight to neutral in EM following our last investment committee meeting. While not forecasting a similar scenario it is worthwhile noting that EM were among the biggest losers during the “taper tantrum” of 2013, when they underperformed developed markets by almost 30% in 2013-14. The potential for a stronger US dollar also represents a possible headwind for the asset class.

Listed real assets

Our positioning in listed real assets has not changed since last month and we remain mildly underweight to real assets as a construct of our mild underweight to listed infrastructure and benchmark position to global REITs (GREITs).

Similar to Australian equities we remain constructive on the outlook for GREITs, however, we remain at benchmark given current valuations and the fact we see better relative opportunities in growth assets, namely emerging markets and developed markets equities.  GREITs remain a critical part of portfolios given their dividend yield, diversifying effect for multi asset portfolios and ability to act as an inflation hedge.

We continue to have a bias towards GREITs and equities over listed infrastructure and remain mildly underweight the asset class as a result. Opportunities to invest further into the asset class could materialise later this year given the ‘lower for longer’ rates scenario and potential for further fiscal support via infrastructure spending. 

Foreign Exchange Hedge Ratio*

Within our diversified portfolios we maintain a mild underweight to the AUD, given it is a risk currency. We prefer more developed market foreign currency exposure (in particular the USD) which should act as a form of protection in the event of any market pull-back.

Defensive Assets


International fixed income

Despite the fact that the Federal Reserve (the Fed) will probably want to maintain breakeven inflation at elevated levels, while maintaining low real yields we believe that if economic activity does indeed pick up on a more persistent basis, real yields will have to follow.

We remain at benchmark to global fixed income, with an eye on decreasing exposure if yields look to persistently trend upwards. We continue to see better opportunities in credit over sovereigns given monetary policy support, the hunt for yield and broader economic prospects.

Australian fixed income

We remain at benchmark in Australian bonds and continue to favour this position to cash within portfolios given the additional yield pick-up. The asset class looks relatively attractive on quantitative metrics with a better fair value & higher carry vs. the other higher beta rates markets including the US, Canada and UK. For now the RBA also remains slightly more dovish compared to the Fed and Bank of England.


We have increased cash in portfolios following the recent move to reduce exposure to risk assets. We are now mildly underweight cash and still prefer the relatively low-risk yield pick-up afforded by fixed income at present.



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

Tactical Asset Allocation is current as at 1 July 2021.



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