Global small caps and EM beneficiaries of economic conditions

Sticky services inflation is keeping inflation higher than expected, and that will likely keep interest rates on hold in the coming months, though Zenith Investment Partner’s Head of Asset Allocation, Damien Hennessy, doesn’t rule out a rate cut by year end.

While goods inflation has come down, services inflation is sticky in Australia, kept up by robust wages growth, according to Mr Hennessy. That could keep interest rates higher for longer in Australia, with financial markets having wound back their bets on a rate cut in coming months.

“The labour market is slowing, so wages growth should eventually drop back. Our expectation is that inflation will stay relatively high over the short term, but we could see a return to some disinflation over the second half of the year, though it will be bumpy,” said Hennessy. 

He predicts a cut in interest rates from the Reserve Bank of Australia in the later part of 2024, possibly in November, with inflation expected to move closer to the central bank’s 2 to 3 per cent band as the Australian economy cools.

“What has happened over the past two to three months is that a no-landing scenario, or an ‘interest rates higher for longer’ scenario, has emerged as the dominant theme. Economies are more resilient than expected and financial markets have unwound expectations for rate cuts,” Mr Hennessy said.

“The soft landing has been our base case and that is how we’ve been building investment portfolios. Still, the outlook for interest rates and economic growth is uncertain and portfolio allocations have to allow for that.

“From a portfolio perspective, we’re targeting areas like adding to duration for bond allocations over the past 12 months. We want to be in a position where we have more bond duration to cope with possible economic scenarios. We also like credit and are slightly overweight high-grade credit, or corporate bonds. 

“In equity markets, we’re targeting the parts of the market that are getting reward for the risk that you are taking, and that includes global smaller caps and some parts of emerging markets. We do still like quality as a factor within equity portfolios.”  Quality companies are characterised by low debt, stable earnings growth and a strong balance sheet, which makes them more resilient to slowing economic growth.

“While we favour certain asset classes, we are not betting heavily on one particular outcome, but we are trying to position portfolios to be able to cope with a range of different economic scenarios,” he said.

With a high level of dispersion in earnings expectations across equity markets and different sectors and stocks, Mr Hennessy said the environment is a good one for active management. 

“The benefit of active managers is that they’re spending their research time and resources on the ground, meeting with companies and researching different assets to gain more in-depth information about investment opportunities. As investors, we benefit from those deep insights and connection with the market,” he said.

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This press release was first published on the Zenith Investment Partners website: https://www.zenithpartners.com.au/news-insights/

An FE fundinfo company headquartered in Australia, Zenith Investment Partners is a leading investment research and managed account provider, with a 20-year track record of delivering premium investment research, fund ratings and investment portfolio solutions for financial advisers.