The synchronised movement in bond and equity prices has many strategists wondering what is going on; both the bond market and equity market cannot be right about future growth.

Following changes to our asset allocation recommendations in May, when we increased our fixed income weighting, bond yields around the world have continued to fall, resulting in returns of around 1.4% from fixed income indices.  Ordinarily, falling bond yields signal investors are nervous about future economic growth, and are therefore likely to swap out of shares into the safety of government bonds.

Yet, over the same period, the US equity market and the Australian market have recorded fresh post-financial crisis highs, implying investors are optimistic about future economic growth.

One theory that has some merit is that the equity market is being driven higher by yield-seeking investors who are not necessarily expecting much in the way of capital growth.

Our asset allocation summary:

• Cash: Move to a slight underweight position. Longer term bank term deposits of one to two years remain attractive relative to at-call cash and government bonds.
• Fixed income: Overweight overall exposure with equal split between Australian and international bonds. Stay underweight long duration government and corporate bonds.
• Australian equities: Remain underweight. Valuations are at the upper end of fair value, meaning attractive opportunities are harder to find.
• Property: Hold a neutral allocation to commercial property with no preference for Australian over global property. Demand for core property is robust and rental growth fundamentals should improve.
• International equities: Maintain overweight allocation, as valuations and growth outlook are more attractive than in Australia. Favour quality companies with strong balance sheets and high returns on equity. Unhedged exposure preferred. Selective (eg mid cap) rather than indexed exposure to emerging market shares favoured.
• Alternatives: Maintain a neutral allocation until opportunities emerge. Manager selection remains more important than strategy selection. Liquid alternative investments including hedge funds remain favoured over equities for incremental risk exposures.

For further analysis, download the full report:

• Your Asset Allocation Strategy (PDF, 1 MB)