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DESPITE yesterday’s news of a continued easing in Australia’s monthly CPI from 7.4% to 6.8%, inflation will remain a key driver of investment markets, just as it was in the first quarter, says our head of multi-asset Michael Blayney.
“While inflation looks to have peaked, it could become sticky in some economies,” Blayney says.
“In the US, for example, it could remain around the four to five per cent range with further falls dependent on softening wages and increased labour capacity.”
Investors are pricing in a normalisation of inflation.
“But markets react relative to what’s priced in. If inflation proves to be stickier than what’s priced in, that creates risks for both bonds and equities.”
Global equity markets have been erratic this year. The first couple of months equities rallied and then they fell back in March.
Where they go to next will be very much about inflation — and it’s similar for fixed income markets, he says.
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“Doubts remain as to whether central banks can engineer a controlled reduction of inflation pressures or whether their actions overshoot and create demand destruction and a deep recession.
“These considerations suggest a cautious risk stance across asset classes,” Blayney says.
For investors, the macro-economic backdrop means they need to seek out opportunities and understand relative valuations.
“Global equity markets are around fair value with Japan and the United Kingdom still cheap and the United States and some European markets still expensive,” Blayney says.
“We are marginally underweight overall, still cautious on downside risks to earnings.”
“Equities have ‘de-rated’ and valuations have become much more reasonable across a wide range of markets.
“But the outlook remains uncertain, given the downside potential in corporate earnings and risks from the lagged impacts of monetary policy tightening,” he says.
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Pendal has now moved to slightly underweight government bonds on a shorter-term basis, Blayney says.
“Global bond yields have fallen significantly from their highs, for example Australian 5 year yields are down 0.8 per cent year to date” he says.
“Higher-starting yields — compared to what were on offer two years ago — provide a degree of insulation. But bonds have already priced in economic weakness on the horizon, so further gains are only likely if the economy gets even worse than what’s priced in now.”
In credit markets, both investment grade and high yield spreads are somewhat higher than their long-term medians, Blayney says.
“But the clouded economic backdrop provides a poor risk-return proposition given the asymmetry in potential outcomes from here,” he says.
“The spreads available do not compensate adequately for the risk of a recession.”
There are opportunities in listed real assets, Blayney says.
“Select listed infrastructure assets with inflation-linked cashflows provide good insulation in case high inflation is more stubborn than currently priced by markets.
“This is particularly true given how the asset class down-rated last year.”
Michael Blayney leads Pendal’s multi-asset team. Michael has more than 20 years of investment management and consulting experience. He was previously Head of Investment Strategy at First State Super and head of Diversified Strategies at Perpetual.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
The team — which also includes Allan Polley — manages our multi-asset portfolios with a focus on strategic asset allocation, active management and tactical asset allocation.
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