The Point

Michael Blayney: How to invest in a recession

The Fed’s rate hikes will likely push the US into recession this year, says Pendal multi-asset chief Michael Blayney.

Some forward-looking US indicators such as the Purchasing Managers Index (a measure of manufacturing health) are showing weakness. We’ve also seen broker earnings downgrades.

“This is one of the most forecast US recessions ever,” Michael says.

But if the US falls into recession, investors should be ready to buy falling equities and take advantage of higher bond yields, he says. Sticking to a long-term strategy is critical, but hold a little more cash than usual.

Michael is underweight US equities, but overweight in “some of the cheaper, more ‘value’ equity markets like Australia and the UK”.

The cycle is also turning towards government bonds he says, though corporate bonds won’t offer the same reward for risk in a recession.

Steve Campbell: RBA likely to move to quarterly tightening in 2023

“Next year should see things change however, with policy tightening likely limited to one or two hikes.

“For many race-goers Tuesday was a tough day. That’s also the case for households with a variable mortgage.

“For households with fixed-rate mortgages mid-2023 and beyond is when the pain is really set to kick in with mortgage repayments about to increase sharply.

“The RBA is more than aware of this. It’s a reason not to overtighten in the first half of 2023.”

Strategic asset allocation: what matters in the long run

Strategic asset allocation is about setting aside the day-to-day noise and thinking about the long term.

For example, three long-term issues that stand out to our multi-asset team are the build-out of renewable energy infrastructure, persistent higher inflation and geo-political risk.

Weighing up these themes and others has led the team to recently adjust their portfolios.

“We’re increasing our exposure to bonds,” says multi-asset PM Alan Polley. “They’re are offering attractive yields and have material diversification benefits. This will also help defend against a potentially more volatile, long-term outlook.

“We’re also moving some capital into sustainable investment companies. With the secular theme of higher inflation, you want more real assets.

“Net-zero carbon emissions commitments provide a tailwind for renewable energy assets and a hedge to energy inflation.”

It’s time to do an annual portfolio health check. Here’s how

A regular portfolio health check is a critical part of successful investing – and doubly so after a volatile 2022.

There are three steps to follow says Alan Polley, a portfolio manager in Pendal’s multi-asset team:

1. Review your strategic asset allocation
2. Consider active asset allocation
3. Ensure sufficient diversification

Risk tolerance and long-term goals shouldn’t change after a negative year, says Alan.

“When markets are volatile, your portfolio can stray away from your risk tolerance, and potentially at the wrong time.

“Buying cheaper asset classes at lower prices the ones that have sold off and are giving you the pain – should add to your returns over time.”

Asset allocation: what our multi-asset team learned in its latest strategic review

Despite a volatile 2022, the long-term outlook for investment markets is more positive than it has been since 2014, says Alan Polley, a portfolio manager with Pendal’s multi-asset team.

The team has just completed its annual strategic asset-allocation process, looking at long-term trends and expected returns across asset classes.

Key to the forecast is improved returns for bonds. US 10-year treasury yields have risen almost 3 percentage points in 12 months, offering attractive yields for the first time since the GFC.

Bonds can once again play a defensive role in a traditional balanced portfolio — often called a 70:30 portfolio for its split between equities and fixed income — as well provide a reasonable level income.

This is even more important for conservative portfolios, which tend to have a higher allocation to bonds.

“Over the last five years or so there’s been commentary declaring the death of the 70:30 portfolio.

“Not only was it never dead, but now it’s definitely back and in a much stronger position than it has been for quite some time.”

Is it time to re-enter the markets? Watch these three measures

Many people are trying to pick the right time to re-enter the market.

Pendal’s multi-asset chief Michael Blayney is closely watching three key market drivers – trend, valuations and economy.

On these three critical measures, it could be time to start inching back into some markets.

“The trend is still negative, though there’s been some short-term bounces,” says Michael.

“On the value side, we’re now at the point where we think in aggregate, equities and bonds are fair value.”

That doesn’t mean the market won’t fall further because investors tend to overshoot on the downside, Michael says. But they ultimately revert.

On the economic front, Michael likes Australia, the UK, Japan and markets with weaker currencies that could support earnings.

“The market is like a three-legged stool. Right now, value has improved. It’s telling you be neutral.

“The trend is still negative and that’s telling you to be underweight.

“And the cycle is still negative, but we are getting more clarity on that. Investors need to be vigilant.”

Alan Polley: Consider foreign currency exposure in international share portfolios

Investors should consider hedging foreign currency exposure in international share portfolios as the Aussie hits 2½ year lows against the USD, argues Pendal’s Alan Polley.

Foreign exchange exposure can offer strong diversification benefits for investors with offshore assets.

The US dollar is starting to look expensive and the Aussie tends to find support at these levels, says Alan.

“In long-term investing you should focus more on the valuation metric – buy things when they are cheap.

“Arguably the Australian dollar versus the USD appears on the cheap side.”

There are a number of important considerations – which Alan covers in detail here.

“But we think a 20 per cent FX hedge ratio on your international equities portfolio balances these various considerations.”