Global equities have rallied over the last 6 months, with the MSCI AC World ex Australia TR Index AUD returning 7.5% since the start of the year. The recovery in global risk assets has however, been quite narrow and heavily concentrated in a small number of US mega stocks. In fact, if we zoom in on the US for a moment, 7 of the largest US tech names are up around 50% year to date, while the rest of the US equity market is flat. The launch of artificial intelligence technologies such as ChatGPT, has created enormous buzz and excitement around potential productivity gains and outsized future earnings of companies across the tech value chain. Unfortunately, when equity recoveries have been this narrow in the past, they have rarely been sustained.
We remain patient and cautious in our positioning. The economic challenges that have been building over the course of the year have not dissipated, rather we think have only been pushed out into the second half of the year. Cost of living pressures (in the form of higher mortgage costs, food & energy prices) are likely to eventually take their toll on the consumer, and ultimately company earnings as the year progresses. New Zealand and Germany have already entered a technical recession, with two consecutive quarters of negative growth, while Australia and the US are also staring down weaker growth prospects. Yield curves in both countries are inverted, historically a pretty reliable indicator of impending recession.
Financial conditions are likely to remain tight as central banks keep a foot on the brake via quantitative tightening and continue their hawkish rhetoric, signalling the potential for further rate rises. While valuations are looking more appealing across a number of asset classes including Australian equities, tight financial conditions coupled with a weakening cyclical environment lead us to believe that the second half of 2023 continues to present some headwinds for risk assets.
While our models are not yet anticipating a deep recession, a period of sub-trend growth warrants a slightly more defensive portfolio positioning. We have neutralised our slightly underweight position in global fixed income, funded by closing out our slightly overweight positions in global listed infrastructure and alternatives. From a valuation perspective, bonds are now looking closer to fair value, and we support the view that traditional fixed income can once again play a defensive role in a diversified the portfolio. We believe that building in some extra defence into the portfolios is prudent as we move into a period of weaker growth.
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