Australia Strategy: Asset Allocation Update – Q2 2022

About the author:

Andrew Tang
Author name:
By Andrew Tang
Job title:
Analyst - Equity Strategy
Date posted:
21 March 2022, 9:00 AM
Sectors Covered:
Equity Strategy and Quant

  • A dramatic escalation of geopolitical risks, commodity prices, the Fed rate hike expectations, and cautious market positioning provides investors with a broad scope of potential outcomes over the next few months.
  • Our tactical allocation favours equities and real assets, with a clear bias for quality. Short-term opportunistic risk hedges (currency, gold) are another option to navigate the uncertainty.
  • We like having some inflation protection with elevated pricing unlikely to unwind given the disruption from the war 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.


A foggy near-term outlook for risk assets

Global equity markets are down ~10% year-to-date, as US bond yields, gold and oil rose, and the Ukraine conflict escalated dramatically following Russian military action. This came as markets also priced a significant Fed hiking cycle in 2022 and some US economic growth indicators slowed.

These factors have left markets at a critical juncture in the short term. On the positive side we could argue that:

  1. Markets are already pricing a significant Fed rate hiking cycle in 2022,
  2. Russia and the US/Europe both have strong incentives not to disrupt key Russian commodity exports (energy or metals) despite the escalation of the Ukraine conflict,
  3. Investor surveys show equity market sentiment is already poor,
  4. The S&P500 is already over 10% off its recent peak, and
  5. There are few warning signals of any impending recession.

Although, negative factors could continue to weigh, such as Russian military action and the Western reaction, posing significant risk for a sharp jump in key energy and metal prices, disrupting the promising global recovery from COVID.

The war has changed the market’s outlook

2022 is likely to have been a worse year for risky assets than we had previously forecast. After all, even if the war ends, the sanctions on Russia are unlikely to be fully unwound. One consequence of this, in our view, is that economic growth – and corporate earnings – will be a bit weaker than we had previously anticipated.

This is especially the case in Europe, which is more economically exposed to the effects of the sanctions on Russia. The blow to the US economy, by contrast, will probably be much smaller.

This doesn’t rule out further gains in risky assets, such as increases in equity between now and the end of the year. It also doesn’t preclude equities in Europe outperforming the “growth”-heavy US market over the remainder of the year as discount rates continue to rise.

But all else equal, it is reasonable to think that year-end forecasts for major equity indices ought to be lower and forecasts for credit spreads perhaps a bit higher.

Second, commodity currencies and commodity-linked markets like Australia are unlikely to give up all their gains. So we suspect that even if de-escalation sees commodity prices ease back, the disruption the war and sanctions have caused to those markets will keep prices elevated.

Key changes to our asset allocation settings

We maintain an overweight position to risk assets but pare back our global equities exposure to neutral this quarter, we remain underweight traditional income assets.

With global short rates edging higher and conditions in place for a return of volatility, we see the need to 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 pandemicSource: 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.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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