Australia Strategy: Asset Allocation Update – 2022 Outlook

About the author:

Andrew Tang
Author name:
By Andrew Tang
Job title:
Analyst - Equity Strategy
Date posted:
29 November 2021, 9:00 AM
Sectors Covered:
Equity Strategy and Quant

  • The path for further gains in risk assets looks to have narrowed after a long run higher, but we reaffirm our tactical pro-risk stance, supported by a broadening global restart and ongoing negative real interest rates. Rising bond yields and elevated valuations will limit the probability of strong capital returns in 2022.
  • Tactically, we stay overweight equities as we expect the tailwinds from the economic restart to overshadow the near-term risks. We tilt toward cyclicality and maintain a bias for quality. We like having some inflation protection with rising prices unlikely to unwind on strong demand dynamics and supply chain constraints. We believe non-traditional return streams (Alternatives), including private credit/equity, unlisted and real assets have the potential to add value and diversification.

Tighter financial conditions to restrain returns in 2022

We forecast that long-term bond yields will continue to rise across most major economies and especially in the US, where we think short-term inflationary pressures are particularly strong. Otherwise, we think the returns from most risky assets will be less impressive in 2022 than they have been over the past 18 months.

That reflects not only a view that bond yields will climb further, but also how we see limited room for global growth to surprise on the upside and how, in many cases, valuations already appear quite stretched.

Inflation is back as a major force influencing policymakers and markets. Shutting and then reopening developed economies has had three distinct impacts: first, simple base effects pushed up inflation, then supply-side bottlenecks emerged and now demand-pull inflation is causing a self-reinforcing cycle of rising wages and more demand in economies like the US.

These pressures are far from universal, as China and Europe are not seeing rising producer prices feed directly into higher consumer goods prices. However, all economic policymakers are being forced to reassess their crisis-period settings and plan for tighter financial conditions ahead. How these forces play out will be the key driver of markets in the coming year.

Journey to net zero

Climate risk is investment risk, and the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios. The green transition comes with costs, yet the economic outlook is unambiguously brighter than a scenario of no action.

Though risks around a disorderly transition are high – particularly if execution fails to match governments’ ambitions to cut emissions. Policy remains the main tool. Some carbon-heavy companies already are changing their business models, creating potential investment opportunities.

We see sustainability-driven repricing as having just begun – with accelerating flows into ESG products a big drive. Commodities such as copper and lithium will likely see increased demand from the drive to net zero.

It’s important to distinguish between near-term drivers of commodities prices – the economic restart – and the long-term transition. Tactical implication: We see opportunities in companies rapidly adapting their business models for net zero.

Key changes to our asset allocation settings

We maintain an overweight position to risk assets and underweight traditional income assets. In line with our updated asset allocation methodology, we introduce Alternatives to add value and diversification to portfolios.

With global short rates edging higher and conditions in place for a return of volatility, we see the need have some dry powder. See page 2 for our asset class views.

Figure 1: Morgans recommended asset allocation settings

Growth stocks have had a choppy ride since the onset of the pandemic

Source: Morgans Financial

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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