Your asset allocation guide – December 2014

Overall, global equity markets are in a sweet spot. China, Japan and Eurozone Central Banks are looking at ways to maintain economic growth, while the United States has completed its quantitative easing and is looking at the appropriate time to raise official interest rates.

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International oil prices declined 30% during October and November.

Part of the decline was due to OPEC’s decision to maintain current production levels and create oil price instability, which appears to be a long-term strategy to undermine the economics of higher cost oil production, including the US’s unconventional shale oil producers.

Globally, lower oil prices should also be a positive tailwind for improved consumer confidence as it transfers wealth from oil producing countries to developed market consumers.

We should see downward pressure on global inflation given that lower oil prices also have second round impacts on the prices of other commodities such as chemicals and goods with a large transport cost component. With lower fuel and commodity costs, households and many companies will have higher disposable income, or net earnings, which is positive for overall growth and for many listed equity sectors.

Lower inflation will also hold down interest rates lower for longer which will benefit economic growth, and the prices of growth assets. Low inflation will also stop bond yields from rising too quickly.

Overall, global equity markets are in a sweet spot. China, Japan and Eurozone Central Banks are either cutting interests or employing massive quantitative easing to maintain economic growth. This has been reflected in the Shanghai-Shenzen Composite Equity Index which rose 10.9% last month and Japanese and German indices also rose strongly.

The US has completed its quantitative easing and is looking at the appropriate time to raise official interest rates. In Australia, interest rate rises are a long way off and there are calls to actually cut rates further in 2015. This in turn augurs well for growth assets where valuations do not appear stretched and a low interest environment is supportive for equity prices.

Our asset allocation summary:

  • Cash: Hold a slight overweight position in cash until better opportunities emerge. We suggest term deposits out to two years are preferred over at-call cash.
  • Fixed income: We suggest an overweight position and an equal split between Australian and (hedged) international bonds. Developed world government bonds are expensive and offer poor absolute value, so prefer products with limited interest rate risk. Tactical and absolute return fixed income strategies, floating-rate corporate securities and short duration fixed income are all preferred over benchmark-aware bond strategies.
  • Australian equities: Remain underweight. Valuations have pulled back but growth outlook remains lower than other markets. Favour selected industrials (I.e. offshore earners) building materials, infrastructure, etc.
  • International equities: Given higher valuations in developed market shares, hold a neutral weighting. Maintain unhedged currency exposure. Favour US, then Japan over Europe. Emerging markets are relatively cheap so direct or indirect exposure is recommended.
  • Alternatives: Maintain a neutral allocation until opportunities emerge. Alternatives represent important diversifiers and as part of an overall strategy of building allocations to assets with a low/moderate correlation to equities.
  • Property: Hold a neutral allocation to commercial property. Demand for core property is robust and rental growth fundamentals should gradually improve. At current pricing, Australian and international property appears fair value.

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