Hemal leads HarbourVest’s efforts in the Asia Pacific region and is responsible for the business in the region. She also works closely with the firm’s regional leaders in the Americas and Europe and the Middle East.
Emma is responsible for analysing the economic backdrop and setting the team’s rate outlook on central bank policy as well as contributing to the top-down and interest rate strategies.
Kerry is responsible for communicating the latest market and economic views from the business’ Global Market Insights Strategy Team. With more than 10 years’ experience, Kerry provides valuable insights and perspectives on the economy and markets to investors.
Michael has over 40 years of experience, having been involved in credit markets since their inception in Australia. With a background in lending and banking, he has an understanding of credit in its purest form.
Martin is a fund manager and involved in the portfolio construction process for the Australian Equity portfolios, while also retaining analytical responsibilities for the Diversified Financials, Food Retail and Chemicals sectors.
Scott leads the Chief Investment Office at LGT Crestone, covering strategic and tactical asset allocation, portfolio construction and manager selection across equities, fixed income and alternative assets. He has more than 25 years’ experience in global financial markets and investment banking.
Stan manages LGT Crestone's model portfolios and leads LGT Crestone's portfolio construction. With more than 16 years' experience in financial markets and managed investments research across multiple asset classes, Stan has a wealth of experience in constructing portfolios and strategies for clients.
Six months ago at our last investment forum one of the key messages on the macro front was “that the mission of central banks had yet to be fully accomplished”. While global growth had continued to moderate, US activity appeared resilient and inflation prints had been sticky. Six months forward, global growth has clearly ebbed weaker (without collapsing), jobs markets have softened (although they are still firm), and inflation has moved lower towards central bank targets. As we have highlighted over recent months, a monetary policy easing cycle has ‘come into view’, with central banks in Asia, Europe, and the UK easing rates, following Canada. Since our forum was held, the US and China have also eased rates.
This has acted as a positive backdrop for markets. Despite some mid-year volatility, markets have continued to deliver positive returns, with equities pushing higher (mostly led by the large-cap stocks), bond-yields moving lower, and credit spreads remaining well contained. Private market returns have remained buoyant for debt, although they have remained subdued for equity. In Australia, growth has been softer and inflation stickier. This has supported corporate earnings, but it has also meant the start of any rate-cutting cycle will now be among the slowest in the G20.
With macro ‘on track’, our panellists discussed where future returns may best be harvested, given equity markets have continued to rise and bond yields have fallen (and may not be far from their new higher longer-term averages). Our panellists considered the risks to equities, given elevated valuations, and where value could emerge in the year ahead. They also debated the renewed diversification role of fixed income in portfolios, despite a more ‘normal’ return horizon post the recent rally. Discussion also turned to the challenge for many multi-asset investors of how to strike the right balance between when, and how much, to invest in private markets.
• An exposure to fixed income still makes sense, with structural drivers supporting future returns: While the equity/bond correlation has not been as negative as in the recent past, bonds still bring diversification to a portfolio. While it is likely time to be more neutral duration (than overweight), given already lower yields, expected higher trend inflation supports elevated nominal returns via income. It is also deemed a more positive environment to be active, given the likelihood of persistent steeper curves. Credit at the quality end is viewed positively, albeit some widening in tight spreads is anticipated.
• Lower rates and solid earnings should support equity returns: Index valuations could be misleading, with more alpha available in cheaper sectors outside tech and healthcare, as non-mega-cap earnings improve on the back of lower rates. Still, earnings growth is unlikely to accelerate materially, and multiples are unlikely to re-rate higher any time soon. The time taken for AI end-use cases to emerge is also viewed as a risk to sentiment (as is geo-political volatility). Across regions, the panel is cautious toward emerging markets, while Japan and Australia are viewed favourably.
• Headwinds for private equity are easing but some caution in private credit is warranted: Private markets remain small relative to their public market peers, providing scope for them to continue to grow, particularly given improved governance. With interest rate headwinds easing, this should provide a more supportive exit environment for companies showing solid operational progress. Secondaries are also beginning to deliver good results, providing much needed liquidity. While private credit returns are expected to stay robust, the risk of too much cash chasing too few good assets remains, heightening the importance of manager selection.
This year, our central case for the world economy has been one where growth would slow, inflation would ease, and rates would start falling around mid-year. With this central case now coming into view, we asked our panellists if a soft-landing scenario could be sustained, or something less constructive would unfold. We also discussed whether the US Federal Reserve (Fed) can meet the market on rates, when the Reserve Bank of Australia (RBA) will likely cut, and what this all means for asset prices.
Kerry Craig, Global Market Strategist at JPMorgan, discussed how income growth in the US has been moderating. This has been coupled with concerns about the strength of the labour market. As such, the market has been grappling with whether we are at the beginning of a ‘soft landing’ or whether we are sliding into a recession. JPMorgan is of the view that we are entering into a soft-landing scenario, since there has not been an extreme tightening in financial conditions. However, it sees the risk of a recession at 20%, which is above the long-term average of 15%.
“You don't have these imbalances in the economy in terms of extended leverage and so you can have this manageable slow down in the growth rate.”
Emma Lawson, Fixed Income Strategist, Macro-economics at Janus Henderson, agrees. She expected that growth levels throughout the rest of the world ex-US would have picked up by now. Purchasing manager indices, however, are beginning to slow, which is a warning signal.
“The longer policy is held above neutral, the greater the probability that we will unexpectedly tip into a recession or a slow growth environment.”
While she is cautious about some of these signals, Janus Henderson’s base case is that growth will be slower, rates will fall, and everything else will normalise. However, the longer rates are held at these levels, the more concerned they are about a less constructive outcome.
Michael Korber, Managing Director, Credit and Fixed Income at Perpetual, feels the central case is relatively benign and policy levers are being pulled in a sensible manner. Within Australia, he is cautious about the risks emerging due to weakness in productivity. Although the RBA started hiking rates later than other major central banks and ‘topped out’ at a slightly lower level, Korber believes we are likely to see an impact in domestic credit markets and the position of levered borrowers. While Perpetual is happy to remain fully invested, it is doing so in a cautious manner.
“There's a headwind coming as a result of those rate rises, as well as weaker consumer confidence. The fat tail risk is not insignificant.”
Hemal Mirani, Managing Director at HarbourVest, expects the cost of doing business to remain high. She sees this being driven by various factors, including a trend towards deglobalisation—or a new kind of globalisation. She also sees geo-politics playing an increasingly important role in investment decision-making.
“Although inflation might be falling, the cost of doing business, whether it's around shipping, or moving supply lines, will continue to be high, which could have a knock-on effect on growth.”
Scott Haslem, Chief Investment Officer at LGT Crestone, explained how the market is expecting a further 230 basis points (bps) of rate cuts from the Fed, but there is a reasonable chance it will not meet market expectations.
Craig explained that JPMorgan thinks it is unlikely the Fed will cut 100bps by the end of 2024, but it may cut 75bps by end year. There is a risk that the Fed will spook the market by moving too aggressively, but expects a relatively moderate easing cycle.
Craig also expects long-run inflation to be higher over time. JPMorgan also expects it to be more volatile, particularly as deglobalisation and geo-politics play out. He believes that this will make it difficult for central banks to think about how far they can cut rates. In the short term, however, inflation is likely to fall in the US.
Lawson explained that Janus Henderson has increased its long-term inflation estimates due to structural factors.
However, she believes that cyclical factors may lead inflation lower in the short term. She explained a key cyclical factor is that China is exporting deflation to the rest of the world. She also added that weak demand may also drive inflation lower in the short term. However over the long term, she sees the neutral rate as being a little higher than previously.
According to Martin Conlon, Head of Australian Equities at Schroders, over the past 20 years, the greatest factor driving deflation has been the rest of the world outsourcing production to China. As inflation has fallen, this has driven interest rates lower, which has then pushed investors into financial assets and property.
Conlon feels that interest rates can be a ‘blunt tool’, and not necessarily that effective at controlling the things we want them to control. He argues that the disconnect between the real economy and the financial economy is as wide as it has ever been, and that wealth inequality has become a major concern globally.
Lawson and Conlon both believe that the neutral rate for the RBA is about 3%. Conlon explained that Schroders is using this number as the basis for its equity valuations, and Lawson discussed how Janus Henderson expects the RBA to lower rates to a little below 3% by 2026. While the RBA is likely to start cutting in February, there is an increasing risk it will start cutting at the end of 2024. Additionally, the Australian yield curve is pricing the RBA to cut rates less than its G10 peers.
We have already seen interest rate cuts from the European Central Bank, the Bank of England and Bank of Canada. Meanwhile, Haslem commented that the RBA is likely to hold rates higher for longer. This potentially creates a risk that we end up reaching a ‘tipping point’ quicker than previously expected.
As Australia began hiking rates later than other central banks, Lawson feels that, if we look at it in very simplistic terms, we can start cutting a bit later. However, she noted that some parts of the economy already feel like they are in a recession, and that the risks in Australia may be higher because of the household sector’s sensitivity to interest rates.
According to Conlon, reducing interest rates will put money back in the hands of younger people who are more likely to spend it. The relationship between rate cuts and asset prices is not obvious as asset prices still rose as rates increased.
In terms of housing, Conlon noted that Australian housing starts per capita are now at the lowest level they have been for the last few decades. Higher interest rates have put money in the hands of older cohorts who have invested primarily in assets. As such, he finds it is hard to see how a cut in interest rates would push property prices higher.
Given the supply challenges the Australian housing market is faced with, Haslem added that it is not obvious that lower interest rates will be helpful in driving demand higher. He also feels that a fall in interest rates may shift supply.
Outside the US, Craig feels growth should have improved more than it has. With the US slowing, the rest of the world needs to grow faster to balance this out.
According to Haslem, China seems to have accepted that its current growth level is the new normal, and does not appear to want to go down the reinflation path. From an Australian perspective, if China’s recovery is consumer-led, this is unlikely to help Australia, as it is not leveraged to housing or infrastructure.
Mirani feels that 4% growth in China is still a solid number. Domestic policy has taken China down a different path, where there is a view the Government is very focused on a certain kind of manufacturing, a certain kind of investment, and does not want the economy to become ‘financialised’.
“It is about jobs; it is about national security. The focus will very much be on new manufacturing and high end manufacturing.”
Craig agrees there will be no big-bang stimulus in China and there will be an increased focus on manufacturing, but notes there has been no demand. However, over the last few weeks China has attempted to change this through various initiatives, recognising that they cannot export their way out of this situation.
Regarding China’s slowdown and impact on Australia, Lawson feels that many of Australia’s industries have now diversified their export base. This means they should not be as impacted by any changes in China’s economy as they were previously.
Panellists are broadly positive on the outlook for Japan, and Mirani commented on how an improvement in corporate governance should allow for better results. Lawson added that wages are beginning to pick up on a more sustained basis, which is providing traction.
Conlon feels that housing is the key driver of inflation in the Western world, while Craig believes that underlying labour markets have also been another source of inflation, given the surge in wage growth. In fact, he feels that labour markets are possibly the more stickier part of inflation as well.
“The reality is there is still very low unemployment and that's not going to fade away straight away.”
The LGT Crestone view: Our central thesis is one of slowing growth, easing inflation, and moderate rate reductions (ahead of a 2025 pick-up). Risks remain as to whether central banks have held rates too high for too long, with the seeds already sown for a sharper downturn in 2025.
Positive equity/bond correlations have presented challenges for portfolio construction in recent years. As a result, investors have been looking at other levers to provide diversification, such as alternative investments and currency. As inflation falls from its high levels, we asked the panel whether this will create a more positive environment for portfolio construction, and contemplated what this means for multi-asset portfolios.
Craig explained that negative correlation is a relatively new phenomenon. 10 to 15 years ago, correlations were positive. On a six- to 12-month moving average, the short-term correlation between US Treasuries and the S&P 500 Index is relatively flat. As inflation falls, JPMorgan feels that this correlation will become negative—but not as negative as it has been in the past.
Where there are peaks in inflation, correlation becomes more positive, which can make asset allocation difficult. However, even if the correlation between equities and bonds is flat, bonds can still act as a diversifier within the portfolio.
“At JPMorgan, we are still leaning into bonds. They're still providing that diversification benefit—it's just not as strong as it was in the past.”
Stan Shamu, Senior Portfolio Manager at LGT Crestone, explained the importance of currency, particularly for people who invest globally. Going forward, the divergence between Australian and US rates could result in an appreciation of the Australian dollar versus the US dollar. The question is then how that feeds into multi-asset portfolios.
Craig agreed and commented that if we were to experience a recession, that could drive a flight back to safety. At JPMorgan, they do not expect to see a recession, but they do expect the US dollar to weaken slightly over time.
“In terms of the rate profile, we think a lot has already been priced in. So, we are thinking about other currencies benefiting from that—whether it’s the euro rising or the Aussie dollar. But I think it will mainly benefit the high-yielding currencies.”
Haslem asked the panel whether investors should be allocating to equities or bonds in a situation where inflation drifts down to central bank targets, growth does not collapse, and central banks are making modest rate cuts.
According to Craig, bonds are the place to be, but their preference is to shift to a more neutral position on duration in the near term and to take risk in credit. Investors also need to be aware of some of the risks around inflation, as well as geo-political risks. More broadly, however, he feels that returns on fixed income should be a lot stronger going forward. Structurally, it does feel like investors should be leaning towards core government bonds at this point.
Korber feels that geo-political issues have made some countries wary of using the US dollar as a reserve currency, with some moving into gold from US dollars. Lawson added that reserves data shows that central banks are decreasing their US dollar holdings.
“It's unlikely to stop being the global reserve asset, but they're certainly moving into gold.”
Craig explained the US Government has not struggled to issue debt, with investor demand for it continuing. A political backlash could eventually be a trigger. Haslem highlighted that diminished Social Security funding (leading to reduced benefits) could also be a catalyst for reform, although this is still about five years away.
The LGT Crestone view: We believe that in the current environment, fixed income and currency are attractive portfolio diversifiers.
An exposure to fixed income has traditionally provided three benefits to multi-asset portfolios: income, diversification, and low volatility. Although volatility benefits have been challenged more recently, the panellists still feel an exposure to fixed income makes sense. We discussed the outlook for government bonds, corporate credit, and whether it still makes sense to be active in fixed income.
According to Haslem, an important factor that LGT Crestone and its clients think about when positioning portfolios is what the neutral rate is for interest rates. They also consider at what point it no longer makes sense to invest in long-term government bonds.
Korber believes we are not too far away from fair value. With the longer end of the yield curve fairly flat and normally-shaped, he feels it is probably close to where it should be (i.e., in the mid-3 area). In an environment where there is still a lot of embedded background risk, fixed income is probably not a bad place to be.
Korber prefers floating-rate exposure, and believes the outlook for cash-plus investing is also positive. He is also cautious about the high-yield end of the credit market, as he feels it is not particularly well priced at the moment. However, there is some embedded equity premium that investors can receive in good quality credit.
Haslem believes that quality credit is attractive from the perspective of the softer-landing narrative.
“While there will probably be some spread widening, it shouldn’t be too much, and credit will still benefit from significant carry.”
When looking at spreads from a historical perspective, Korber does not believe they are particularly tight, and feels that risk premia may increase slightly.
“The market has bottomed out for a bit and hence he would keep exposures reasonably short duration.”
In general, Lawson feels that the environment is good for fixed income and now is a good time to be active. In terms of the Aussie-US spread, there is a carry advantage for Australia into the end of the year and beginning of next year. She is concerned about the long end embedding a greater term premium for US debt risk. Although the US dollar is the global reserve currency, she worries about the extensive level of US debt and how the long end of the US market will perform.
Haslem asked the panel whether the absolute level of US debt or the change in the supply of debt is the concern. He feels the US’ current 6% deficit will be the same next year too. While Australia’s level of debt is low, it is getting higher, putting more pressure on the RBA’s ability to trim rates.
“We're stimulating the economy and making the RBA’s job harder. It’s difficult to say the US Government is making the Fed's job any harder. It's just bad.”
According to Lawson, as time goes by, if you look at the interaction of outright yields with global demand for reserve assets, China is a substantial net marginal buyer of those assets, which makes them susceptible to geo-political risk. Over time, this creates a headwind. Lawson believes this will likely become a US problem, but Australia will probably avoid this.
The LGT Crestone view: Within fixed income, we favour investment grade credit to take advantage of attractive yields and supportive economic conditions. We are overweight Australian government bonds, as we believe markets are underpricing the potential for RBA cuts over the coming year, but believe there is limited capital upside from global government bonds.
Equity markets have continued to be resilient, posting fresh highs, despite signs of a potential slowdown in the economy. We asked panellists whether current equity valuations are stretched in the US and Australia, what the outlook is for other regions, and whether there have been any learnings from the recent reporting season. How stretched are current equity valuations?
At an index level, Haslem feels that valuations have an air of vulnerability around them. As the headwind of higher interest rates dissipates, it may still not be enough to help equity markets advance.
Conlon does not feel that multiples of 17x in Australia are extreme, and commented that averages can be misleading. This figure is made up of tech stocks and healthcare stocks (some of which are trading at 100x and
35x respectively). Similarly, there are other stocks in energy and materials that are trading as low as 12x. Trading volumes are collapsing relative to the size of equity markets globally as passive and quant styles take over, and some fundamental investors are becoming more momentum-based.
While headline valuations in Australia and the US do seem high, Craig noted that, on a historical basis, they have been higher, and he does not anticipate a large re-rating. Looking at the outlook for earnings growth in the US, consensus is forecasting 15% next year, which, in his opinion, is a little high. While earnings may disappoint, companies are still growing, but we may not get positive returns from the market. He feels we are likely to see more earnings growth from the non-mega caps. However, any uncertainty about the growth outlook is likely to push investors back into mega-cap names because of their quality bias, and small- and mid-cap stocks carry risks if the economy were to slow.
Mirani believes that the ‘magic’ of artificial intelligence (AI) has influenced valuations. However, as investors begin to assess what the end use cases are for AI and the costs associated with it, some tech stocks have begun to retreat.
Haslem explained that some of the value in equity markets is predicated on analysts’ expectations that margin expansion lies ahead—although it is not obvious that further expansion is possible. Conlon cannot see margins growing much from here, especially as labour costs are demanding a greater share of margins— particularly in industries where workers have bargaining power. Conlon explained that a company’s market power will likely be an important theme in coming years. He sees tech companies having greater market power than any other industry and they will likely continue to use this to their advantage. However, he believes most margin expansion is the result of price inflation, not efficiency or productivity gains.
Conlon feels the reporting season was reasonably positive, and reflects that Australia has not experienced the stressed economic conditions that other markets have. Even discretionary retailers, which are at the front end of consumer sensitivity, have held up reasonably well. JB Hi Fi and Super Retail have reported solid results, and other companies have seen improved sales numbers versus earlier in the year. While profits from resource companies are under pressure, he does not feel these companies are in distress. “There’s generally not much debt either— underlying companies are sensibly geared; profit margins are still fine.”
Conlon explained that resource stocks have been challenged, given weaker commodity prices. As investors have been looking for the ‘next worst thing’, there has been increased interest in bank stocks, despite profits being flat. Schroders believes that commodity prices are close to troughing. If this happens, we could see a commodity-price reversal, which would support resource stocks.
With regards to regional equities, the panel is cautious on emerging markets. Craig feels that Japan is an attractive opportunity because of the changes in its corporate governance. JPMorgan is more cautious on Europe, which is being impacted by the slowing in China, such as in the luxury market, manufacturing, and autos.
The LGT Crestone view: We have recently increased our overweight to equities, reflecting our central case for a soft-ish landing and supportive central banks. We are overweight domestic equities, US equities, Japan equities, and we have recently closed our emerging market underweight and are now neutral.
Private markets have served investors well over the past decade, and 2021 was a particularly strong exit market for private equity. The challenge for many multi-asset investors has been how to strike the right balance between when to invest in private markets, when to invest in public markets, and what the balance should be over the long term. We asked the panel for their views and how they see private credit performing in the period ahead.
Mirani explained that as private markets are much smaller than public markets, there is room for them to grow. She commented on how private markets have become more sophisticated over the past 10 to 20 years, and governance has improved when looking at the alignment between managers and investors, as well as portfolio companies. Management has been given an incentive to improve results for these companies and to deliver positive results for investors. This close alignment is critical and often overlooked by exchange-traded funds and the largest portfolio companies that are bought on the public side. Tech stocks have driven benchmark performance, although there has been a divergence in performance, but Mirani questions how much further they can grow. She feels that the secondary market is beginning to deliver good results and provide liquidity. Looking ahead, Mirani is constructive on private markets, and expects M&A activity to deliver liquidity.
Shamu emphasised that it is important to partner with the right manager, particularly in a difficult market environment, and that the cost of debt has been an issue for private markets. While the rate-hiking cycle has been a challenge, Mirani feels the onset of rate cuts should provide some breathing room to many of these companies. A decade ago, it was the banks who were lending—but today, that lending is coming from credit funds.
Korber believes that many of the developments in Australia’s private credit market have been positive. However, he believes we may be entering a part of the market cycle where there is more money than good assets available, and sees a willingness to embrace more risk around assets. Part of this is driven by comfort with asset valuations—i.e., collateral lending. Perpetual believes in cash flow lending.
“We want to lend to businesses that can generate cash returns and can recapitalise.”
According to Mirani, a positive trend for the private equity industry has been the tendency for credit funds to try and keep businesses afloat when they were running into financial difficulty. Key risks will be periods when investors need liquidity or they will be concerned about how long it will take to get liquidity. In these situations, they may feel like they have an over-allocation to private equity and market dislocations could happen.
The LGT Crestone view: We favour infrastructure, private debt, hedge funds and diversifying strategies. We are becoming more constructive on real estate globally, and anticipate that the next three to six months should present an attractive long-term entry point for those looking past short-term volatility.
“I would allocate to semi- government bonds, high yield, and effective government guarantee.”
“As geo-politics are an ongoing risk, I would allocate to private markets, with a focus on secondaries.”
“The greatest risk is the consumer stops spending and there is a potential slowdown in growth. I’d be investing my marginal dollar into the fixed income market.”
“I like commodity stocks, as they provide inflation insulation and mitigate the risk of governments spending more than they collect in tax.”
“I like investment grade credit, floating-rate credit and good quality private debt, as geo-political risk could impact liquidity.”
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