Global Asset Allocation Viewpoints and Investment Environment by T. Rowe Price Australia Investment Committee, as at 31 July 2023.
MARKET PERSPECTIVE
- Despite expectations for slowing global growth in the back half of the year, some regions are proving more resilient in the face of tighter financial conditions, bolstered by strong household and corporate balance sheets.
- The U.S. economy has been more robust than expected, while Europe has navigated a mild recession in Germany and continues to combat inflationary pressures. Chinese growth has disappointed, while Japan continues to benefit from an uptick in domestic demand. Meanwhile, domestic demand in Australia is starting to feel the pain of tighter financial conditions.
- While global central banks are likely near peak tightening, they remain vigilant on inflation as it is proving stickier in some regions, such as Europe and the UK and are at the ready to take further steps toward tightening depending on trends in the data.
- Key risks to global markets include a deeper than expected decline in growth, central bank missteps, reacceleration in inflation, tight credit conditions and geopolitical tensions.
MARKET THEMES
Insensitive
Despite the fed funds rate reaching its highest level in over 20 years, the U.S. economy has proven more insensitive to higher interest rates than many would have expected so far. Typically, as rates move higher the economy slows leading to weakness in the labor market which then flows through to the consumer. However, labor market tightness has supported real income gains amid moderating inflation and excess savings have kept consumer balance sheets strong, ultimately buoying the broader economy. Additionally, with fixed-rate mortgages making up most of the U.S. home loan market, higher rates have not had the same impact that they have had in other regions dominated by floating-rate mortgages. Corporations have also proven less sensitive to higher rates given previously refunding debt at low rates well as capex funding being supplemented by fiscal stimulus programs, rather than from loans at high interest rates. While so far it appears the economy may be less sensitive to higher rates than in previous cycles, it is also possible that policy has not been restrictive for long enough to have its desired effects on the economy.
Taking Shelter
Shelter inflation, which includes rent of primary residence and owners’ equivalent rent of residences (OER), is coming off its recent highs.
OER closely tracks home prices which have shown declines year- over-year. Given the two components make up nearly one-third of the consumer price index (CPI) and have a lagged impact on CPI, hopes are for softening data to start to pull down overall inflation in coming months. While this would be a welcomed sign for the Fed, recent data showing resilience in the U.S. economy is starting to raise concerns of inflation stagnating or possibility inflecting higher. With a backdrop of a still tight labor market, a strong services sector, consumers still holding excess savings and a recent spike in energy and food prices, there are plenty of reasons for the Fed to remain cautious. Investors and the Fed, alike, will be eyeing details as the decline in shelter inflation may be masking a move higher in other underlying components if the economy continues to surprise to the upside.
PORTFOLIO POSITIONING
- We kept our modest underweight to equities as valuations remain elevated despite expectations for the global economy to slow in the back half of the year.
- Within fixed income, we added to cash to benefit from the inverted yield curve. We maintained some duration exposure in Australia and in the US though despite being underweight overall as bonds remain vulnerable to further central bank tightening.
- Within equities, we remain overweight areas of the market with more attractive valuation support, such as Japan, small-caps and emerging markets, which could benefit from broader equity participation in the recent rally.
- Within fixed income, we are positioned with overweights to return-seeking sectors through high yield, and emerging market bonds; as well as to Australian govies and long-term U.S. treasuries as duration ballast.
Note: T. Rowe Price’s Australia Investment Committee comprises local and global investment professionals who apply views from the firm’s Global Asset Allocation Committee to make informed asset allocation views from an Australian investor perspective. The Committee is led by Thomas Poullaouec, Head of Multi-Asset Solutions APAC, based in Singapore.
