October 15, 2021

Market Update – October 21

Market update

Investors are currently facing several challenges in formulating their portfolio investment strategy. 

Covid continuing to disrupt the economic recovery 

While vaccination rates in most developed countries are approaching levels which will protect their health systems, the low vaccination rates in less developed countries continues to disrupt supply chains which is having significant impacts.

Australia is about to see if opening up, particularly post December, will spur the economy to another rebound.  The IMF has reduced its forecast for Australian real GDP growth from 5.9% to 3.5% for 2021 but has increased its forecast for 2022 from 3.0% to 4.1%.  In effect, it is forecasting a delay in the recovery. The IMF is also forecasting real growth in global GDP of 5.9% in 2022.

 Gita Gopinath, the chief economist of the IMF, referred to the risk of heavy price falls in developed market residential real estate over the next three years as an additional risk factor. The IMF is forecasting a potential 14% drop over the next three years. 

Inflation

Inflation has picked up in both the European Union and the USA.  The question is whether this is a temporary phenomenon caused by supply chain problems or whether it will build into expectations and become more persistent via increases in wage rates.  It is likely that over the next three-year period the central banks will refrain from pre-emptively increasing interest rates to choke off inflation.  If it turns out they are wrong about the subsidence of inflation within a few years, they will likely push interest rates up more firmly from 2023 onwards.

Mistakes by policy makers

There are four main engines driving the world economy: the USA, the Peoples Republic of China, the European Union and Japan. The two main engines:  the USA and the PRC are both being driven by what have been referred to as old men in a hurry. Both want to effect significant policy change within their domestic settings. Both have challenges to overcome in effectively making these changes.

In the USA the fractured nature of the legislature the Congress will very likely mean that the fiscal policy adopted including infrastructure spending will become a very piece meal programme with less effective stimulus than anticipated by markets. Disappointment will lead to short term selloffs in equities which will be recovered within six-to-twelve-month periods.

In China, the leadership have less concerns about opposition from either a legislature or the media. Their challenge is that they are attempting to decarbonize the economy while maintaining energy supplies to important industries and cities and also trying to deflate a major real estate bubble.  It may be that not all of this can be done at the same time.

 

Investors should:

·        From a longer-term perspective, maximise the asset allocation to equities subject to meeting their perceived need for a reduction in the shorter run volatility of portfolio returns (achieved by holding more cash and/or fixed interest at a cost of accepting a negative real return).

 

·        Maintain a portfolio allocation to equities of at least 100% of the neutral or benchmark or long-term strategic weight for the relevant risk profile within the framework that applies to the portfolio.

 

·        Overweight international equities

 

·        Underweight Australian equities, due to its concentrated composition and the risk inherent in its reliance on the Chinese economy.

 

·        Carefully and selectively manage investment in equities, due to the wide dispersion between winners and losers that is expected in the new environment. Investing through active equity managers with proven stock selection skills, regardless of how they are labelled (e.g., value or growth) is an optimum strategy to adopt.

 

·        Invest any so-called defensive assets (cash or fixed interest) with a shorter duration (to avoid losses if bond yields rise) and only in low or well-managed credit risk. Refrain from investing in cash or fixed interest that has significant corporate credit risk, unless it is via a fund managed by managers with proven credit risk assessment skills. 

Extracted from Purvis Investment Market Conditions Report – 14 October 2021.  This information is general advice only and does not take into account your personal circumstances, goals and objectives. Therefore, you should consider its appropriateness for your circumstances before acting on this information.

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