Our latest Capital Markets analysis highlights a continued upward improvement in the forecast return and yield metrics across the majority of asset classes as global central banks come to the end of their cash rate tightening cycle as inflationary expectations peak. Nevertheless, while inflationary expectations have passed their high point, the lead time and path for inflation to reach central bank target levels will be longer and more volatile. In addition, we see fewer rates cuts and higher terminal cash rates through the cycle going forward. However, in the avoidance of a broader global recession, this does provide a backdrop that can continue to support higher asset prices, despite an economic environment where both global growth and labour markets continue to soften.
Since our last review, our forward looking view of financial markets as well as the global economy is one of cautious optimism. While there are no shortages of challenges facing financial markets and the global economy, the resilience of major economies, particularly the US, provides a positive backdrop for an ongoing upward movement in financial markets going forward. The performance of several major global equity indices reaching all-time highs through the 1h24 highlights that financial markets are focused on the next phase of the cash rate cycle, inflation and growth outlook. Against this backdrop, financial markets have the ability to solidify gains, while the global economy can continue to move forward. We see the opportunity in those parts of the market that have not enjoyed the same level of performance of the major bourses and can benefit from future declines in global cash rates. This includes the more cyclical and interest rate sensitive parts of the market as well as those sectors that are ‘leveraged’ to a broader economic recovery.
Given this macro environment, our asset allocation framework has also evolved since our previous Capital Markets Paper. While we previously sought to maintain a focus on increasing diversity across our portfolios with a focus on large cap quality (developed market equities) along with an increasing allocation to fixed income (Treasury) as bond market valuations improved, while at the same time avoiding the higher risk segments of financial markets such as emerging markets, small caps (Aust, global) and interest rates sensitive sectors such as REITs (Aust, global), this has now changed. Today, we see a different investment environment going forward and with that, a further broadening of the opportunity set, premised on the back of stable economic growth, supportive central bank policy, ongoing government fiscal spend, a sound corporate earnings outlook and steady labour markets. While each of these may exhibit their own levels of ‘volatility’ through the forward cycle, we remain constructive on the medium term outlook for financial markets.
Finally, some key market themes that have helped drive financial markets in recent periods we believe will continue, but it is clear that some structural changes are beginning to be more pervasive. To this end the three key themes that we see shaping financial markets both in the near and medium term are higher cyclically based inflation, the ongoing energy transition to net zero and the prevalence and growing importance of artificial intelligence (AI). While inflationary expectations and the energy transition have been impacting financial markets for some time, the rapid development and impact of AI will have a demonstrable impact on every facet of individual lives and by consequence financial markets as we move through the rest of the decade and beyond.
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