Alex Cathcart, CFA, Economist, Investment Strategy
For the QSuper ReadyMade options – Balanced, Moderate, Aggressive and QSuper Lifetime – our investment portfolio strategic positioning is determined within the asset allocation ranges set by the QSuper Board.
The precise asset class weightings (i.e. the amount of equities, fixed interest, real estate etc.) within these ranges are informed by the valuations of these asset classes, our economic outlook and the risks, as we perceive them, to this outlook.
So how do we currently view the outlook and has this changed much from earlier in the year? Our longer term expectation is for continued moderate global growth, a recovery in inflation back towards central bank targets and a very slow normalisation in monetary policy, with the US more advanced in this process than other economies. This profile is consistent with low, but positive, portfolio returns as we’ve discussed before.
In early October the International Monetary Fund released its World Economic Outlook. This presents a very similar forecast profile for global economic growth to what we have seen recently. It forecasts global growth of 3.1 per cent in 2016 and 3.4 per cent in 2017. Further, this outlook sees weakness this year concentrated in Russia and Brazil. Both are forecast to see modest returns to growth in 2017. India is still forecast to be the fastest growing economy in 2016 and 2017.
Among this generally positive outlook, the foundations for central banks’ accommodative policy settings seemed to be less concrete through September. US Federal Reserve speakers again started talking about financial stability and a desire to increase rates. The Bank of Japan shifted its policy tool from asset purchase targets to ‘yield curve control’ where it will buy long-term government bonds in an attempt to keep 10-year bond yields around 0 per cent. This is part of an overall policy framework aimed at lowering real interest rates1.
The European Central Bank (ECB) also disappointed markets by not announcing an extension of quantitative easing (QE) once the current program expires. Commentators are talking about the potential for the European Central Bank to begin reducing or tapering the amount of money it feeds into the Euro zone economy, much like the US Fed did over 2014.
US and Australian 10 year bonds have sold off around 30 basis points from their calendar year minimums, and EU and Japanese bonds are off around 20 basis points. While these are very minor moves in the context of the rally we have seen in recent years, it’s unclear whether this trend will continue (our forecast is for a gradual rise in yields).
However, current bond pricing is sensitive to expectations of ongoing central bank support (via QE), very low inflation expectations and effectively no monetary policy normalisation across the developed world. These expectations are of course not without merit. Global growth is low, inflation is low and major central banks have committed to ongoing policy accommodation. We merely highlight that the risk is not all one way for the asset class, and while our broad expectation is for rates to rise slowly, our mantra is to be prepared for a full range of outcomes.
The immediate risk to equity-like assets on the horizon are political: (1) the US election (second Tuesday in November) and (2) the Italian referendum on constitutional reform (early December). A negative outcome in either could spark a sell-off. Although we still think the primary risk to our outlook is a China debt, banking or economic crisis.
Reflecting these concerns and somewhat elevated asset valuations, we hold a little more cash than we normally would in the portfolios. Should we see an improvement in valuations for either bonds or equities, we would look to deploy some of this cash back into these risky asset classes.
1. The real interest rate is the rate of interest an investor or lender receives after allowing for inflation.
The views of the author are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and as such it doesn’t take into account your personal financial objectives, situation or needs. You should get professional advice before relying on this information.
Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.
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Economist – Portfolio Manager Support, Investment Strategy
Alex is responsible for forecasting major global economies, monitoring global economic and financial market conditions, and providing support to the portfolio managers.