Key Points: 

  • Stay overweight risk assets, despite US yield curve inversion. It’s not only the US yield curve that is signaling a US recession. Key business surveys are also beating the same drum. However, these signals lead the large equity market drawdown associated with recessions by at least 6 months and investors shouldn’t hit the panic button. There is still some hope the supply-side inflationary pressures may ease leaving the Fed some room, even though this is looking less likely.
  • Take some profit on Australia and buy Japan. Our overweight position on Australia has been rewarded this year and we now recommend taking some profit, by remaining just a little overweight. Japan is now our preferred equity market exposure over EM, with Australia third in line followed by the US and Europe. Australia’s earnings outlook underpins our positive stance on the local market.
  • Australia’s outperformance has been driven by Resources, Energy and Banks. Cost pressures were one of the key issues during reporting season. However, analysts expect margins to expand in Transport, Auto Components, Media and Entertainment, Energy, Commercial services and Software. The expectation of margin expansion in transport seems at odds with expectations of margin expansion in the Energy sector.
  • Retain the overweight on Global property. Despite the substantial rise in bond yields since our last update, the asset class has performed strongly. Global infrastructure has also performed strongly, but valuations aren’t as attractive as they are in Property.
  • Reduce the Value exposure in equities. Value has outperformed Growth again so far this year after underperforming in H2 last year. However, this outperformance reached extreme levels and looks vulnerable to a resurgence in Growth. The term premium on the benchmark US 10-year yield has fallen and Growth’s valuation premium is now around long run average levels.
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