Persistent Inflation, Higher Bond Yields and Positioning for the Next Market Rotation

The Investment Committee’s latest discussion centred on a market environment increasingly defined by persistent inflation, elevated energy prices and a repricing of global bond yields.

The Committee’s view is that the investment environment is shifting away from the conditions that favoured expensive growth assets and toward a regime where real assets, commodities, pricing power, strong balance sheets and income become increasingly important.

While global growth remains positive, the Committee expects economic momentum to moderate as higher borrowing costs, rising energy prices and cost-of-living pressures increasingly affect households and businesses. The central portfolio challenge is therefore balancing protection against inflation and slower growth while remaining positioned for opportunities that can emerge as markets begin to look through the current tightening cycle.

Inflation remains the dominant investment issue

The Committee believes markets are increasingly accepting that inflation may remain elevated for longer than previously expected.

Recent strength in U.S. manufacturing and composite PMI data, combined with weak demand at Treasury auctions, has pushed bond yields back toward levels last experienced before the Global Financial Crisis.

The concern is that inflation is no longer being driven by a single factor. Energy costs remain elevated, food prices could become the next major source of pressure, and transport costs are beginning to flow through supply chains.

The Committee specifically noted the potential for higher diesel prices to increase transport and production costs, while major Australian supermarkets have already warned consumers about the possibility of further food-price increases.

Weather conditions could add another layer of pressure if agricultural production is disrupted.

This environment continues to support a preference for companies capable of passing higher costs through to customers without materially affecting demand.

Bond yields are changing the investment equation

Bond markets remain central to the Committee’s outlook.

Long-term U.S. Treasury yields have continued to rise, with 30-year yields approaching 5.5% and shorter maturities also moving higher.

The Committee sees this as evidence that investors are demanding a higher return to compensate for inflation, fiscal deficits and long-term government borrowing requirements.

If long-term government bond yields continue moving toward 6%, the relative attractiveness of equities could change materially. At those levels, investors may be able to earn historically attractive returns from government bonds without assuming equity-market risk.

This could place considerable pressure on expensive companies whose valuations depend on earnings many years into the future.

The Committee therefore continues to favour shorter-duration fixed interest rather than locking portfolios heavily into long-dated bonds while yields are still rising.

There was also discussion around fixed-maturity bond structures offering yields in the region of 5.5%–6%. These may become attractive once the Committee is more confident that the rate-hiking cycle is nearing completion, although the current view is that it may still be too early to materially increase exposure.

Australia: a “stagflation-light” environment

The Committee remains cautious on the Australian economy.

The current environment has several characteristics of stagflation: economic growth is slowing while many important costs continue to rise.

Higher fuel prices are affecting transport, construction and government infrastructure projects, while higher mortgage rates and living costs are placing pressure on household cash flow.

The Committee also noted increasing signs of difficulty among small businesses and construction companies where contracts were priced before the recent surge in input costs.

This supports an overall underweight position in Australian equities, particularly across the more economically sensitive areas of the market.

However, the discussion also highlighted that the Australian consumer is not uniform.

Higher-income households and retirees with significant assets appear considerably better positioned than younger families and mortgage holders.

This “K-shaped” economic environment means some consumer businesses may continue to perform even while aggregate household conditions remain weak.

The implication is that broad sector labels such as “consumer discretionary” may become less useful than identifying companies serving financially stronger customer groups.

Consumer discretionary: beginning to look through the downturn

One of the most significant changes in the Committee’s positioning was a willingness to begin considering selected consumer discretionary companies.

The Committee remains underweight the sector overall, but believes markets may be approaching a point where the economic bad news is increasingly reflected in share prices.

The central argument is that equity markets typically price economic conditions six to nine months ahead.

This means the best opportunities can appear while current economic data are still weak rather than after the recovery has become obvious.

JB Hi-Fi

JB Hi-Fi was identified as one potential beneficiary of an eventual improvement in consumer conditions.

The share price has fallen significantly from previous highs, creating a more attractive starting valuation.

The Committee acknowledged that discretionary spending could weaken further as food, energy and mortgage costs rise, but believes the business is well positioned to benefit once consumers become more confident.

The investment approach is therefore not based on calling the exact bottom, but beginning with a smaller allocation that can be increased if the recovery becomes more evident.

Harvey Norman

Harvey Norman was also discussed as a contrarian opportunity.

Part of the attraction is the substantial value of the company’s underlying property portfolio.

The Committee noted that the shares were trading at approximately the value of the company’s underlying assets while also offering a dividend yield approaching 7%.

This creates an investment case that is partly consumer discretionary and partly a real-asset exposure.

In an inflationary environment, ownership of physical property may provide additional protection compared with businesses with limited tangible assets.

Following the discussion, the Committee agreed to establish an initial 1% allocation to both JB Hi-Fi and Harvey Norman rather than immediately moving to full positions.

The intention is to gain exposure to a potential recovery while retaining the flexibility to increase allocations if the investment thesis strengthens.

Resources remain a preferred inflation hedge

Resources continue to form an important part of portfolio positioning.

The Committee remains constructive on copper due to increasing demand from electrification, defence expenditure, power networks and AI infrastructure.

Supply remains relatively constrained, with few major new copper discoveries capable of quickly increasing global production.

This provides a structural backdrop that the Committee believes could support copper prices over a long investment horizon.

Uranium is also becoming more attractive as higher conventional energy prices increase the economic incentive for governments to expand nuclear generation.

More broadly, the Committee continues to prefer exposure to real assets and commodities in an environment where inflation remains elevated and government spending continues to support infrastructure investment.

Gold remains a core portfolio diversifier

The Committee remains overweight gold.

Persistent inflation, elevated government debt, geopolitical uncertainty and the risk of further intervention in bond markets continue to support the strategic investment case.

The Committee believes diversified portfolios should retain a meaningful allocation to physical gold or gold bullion exposure, with approximately 4% discussed as a minimum portfolio position.

Gold is not viewed simply as a short-term geopolitical trade. Rather, it is being used as a hedge against currency debasement, inflation and broader financial-market instability.

United States: neutral overall, selective underneath

The Committee remains broadly neutral on the United States.

Economic activity has remained relatively resilient, supported in part by significant investment in artificial intelligence and data-centre infrastructure.

However, higher bond yields and stretched valuations mean the Committee is reluctant to materially increase broad U.S. market exposure.

The preference continues to be selective rather than buying the entire market.

The Committee expressed particular concern about the concentration of major indices in the largest technology companies.

Some businesses such as Microsoft, Meta and Alphabet were viewed more favourably, while greater valuation concerns were raised around Apple, Amazon and Tesla.

The Committee does not currently want to materially increase exposure to a concentrated Magnificent Seven or Nasdaq strategy simply because those stocks have recently performed well.

Doing so would conflict with the portfolio’s existing objective of reducing exposure to an eventual correction in expensive mega-cap technology.

Instead, additional international equity exposure is being directed toward diversified active strategies including Plato and Acadian, where the Committee believes downside capture and broader regional diversification are more attractive.

International equities: gradually increasing exposure

The Committee agreed to increase overall growth exposure from approximately 62% to 65%, moving the portfolio modestly closer to its strategic allocation while remaining defensively positioned.

The rationale is that markets have already experienced part of the correction the Committee had anticipated.

While further volatility is possible, the Committee does not currently expect conditions to deteriorate severely before the next Investment Committee meeting.

This creates an opportunity to gradually increase international equity exposure rather than waiting for perfect clarity.

Europe: approaching a more attractive entry point

Europe remains an area of growing interest.

Valuations are generally cheaper than those in the United States, while economic conditions remain relatively resilient.

The primary risk remains energy.

If energy prices stabilise, the Committee believes European financials, industrials, defence companies and utilities could become increasingly attractive.

For the time being, the Committee is watching rather than aggressively increasing exposure, but Europe remains high on the list of potential future opportunities.

Japan: positive, but the easy gains may have passed

Japan remains constructive from a long-term perspective.

Improving wages, advanced manufacturing investment and gradual normalisation of monetary policy continue to support the market.

However, the Committee believes much of the easy valuation rerating has already occurred.

The preference is therefore to retain existing exposure while focusing on specific areas including banks, insurers and automation rather than materially increasing broad Japanese equity exposure.

China and Asian technology

China continues to operate as a two-speed economy.

Property and housing-linked areas remain weak, while AI, semiconductors and advanced technology continue to attract significant government support and investment.

The Committee remains constructive on Chinese and broader Asian technology because these economies occupy an important position in global semiconductor and technology supply chains.

The existing Asia technology ETF was reviewed, with approximately 41% exposure to Taiwan and 28.5% to South Korea.

The Committee believes this already provides meaningful exposure and does not currently see a need to materially increase the allocation.

There was also discussion of more concentrated semiconductor memory exposures, including DRAM-related investments.

These were acknowledged as potentially attractive but significantly higher-beta opportunities than the Committee’s current portfolio positioning.

Emerging markets

Rising global bond yields and a stronger U.S. dollar remain headwinds for emerging markets.

The Committee therefore continues to prefer Asian emerging markets because of their connection to global technology, manufacturing and supply chains.

Resource-producing emerging markets may also become increasingly attractive if commodity prices remain elevated.

The overall approach remains selective rather than treating emerging markets as a single asset class.

Private credit: scrutiny remains elevated

Private credit remains under close review.

The Committee is developing an internal quantitative and qualitative analysis tool to assess private credit managers more consistently, particularly around underlying loans, liquidity, security, refinancing and concentration risk.

The discussion highlighted that the sector should not be viewed uniformly.

Large diversified managers may be able to absorb individual problem loans without materially affecting overall portfolio outcomes.

However, the Committee remains concerned about liquidity, valuation practices and the extent to which individual loans can be accurately priced during periods of stress.

Another important issue is competition.

Large global private equity managers have accumulated significant capital but are finding fewer attractive transactions.

Some of this money has flowed into private credit, increasing competition among lenders and potentially compressing lending margins.

This could reduce future returns even while underlying credit risks remain elevated.

The Committee therefore remains cautious about chasing headline yields and continues to prioritise liquidity and transparency.

Property and infrastructure

Higher bond yields continue to create valuation pressure across listed property and infrastructure.

The Committee remains underweight traditional office property because higher long-term interest rates increase discount rates and reduce the relative attractiveness of property yields.

However, individual opportunities remain.

DEXUS was retained, with the Committee noting improving occupancy and attractive yields despite short-term valuation pressure from rising bond rates.

The position is increasingly attractive if the underlying assets continue generating stable income while the listed security trades at a substantial discount to net tangible assets.

Infrastructure remains a preferred long-term theme, but existing holdings are being reviewed to ensure they provide the desired exposure.

The Committee requested further analysis of the current infrastructure allocation relative to peers, along with research into transport and logistics infrastructure that could benefit if global trade conditions improve.

Portfolio positioning

The Committee’s current positioning can be summarised as:

• overweight gold and selected resources;
• maintain exposure to copper and uranium;
• favour healthcare, insurance and infrastructure;
• remain selective within China and Asian technology;
• underweight Australian banks;
• underweight traditional office property;
• underweight consumer discretionary overall, while initiating small contrarian positions in JB Hi-Fi and Harvey Norman;
• favour shorter-duration fixed interest;
• remain cautious on highly concentrated U.S. mega-cap technology;
• gradually increase diversified international equity exposure; and
• continue scrutinising private credit, particularly liquidity and refinancing risk.

Conclusion

The Committee believes investors are moving into a different market regime from the one that dominated much of the past decade.

Inflation is proving more persistent, long-term bond yields are rising and the cost of capital is becoming structurally more important.

In this environment, portfolio returns may increasingly depend on owning assets with genuine cash flow, tangible value, pricing power and structural demand rather than relying on continually expanding valuation multiples.

At the same time, the Committee is beginning to look beyond the current slowdown.

Selected consumer discretionary companies are approaching more attractive valuations, international equities are being gradually increased, and the Committee is preparing for opportunities that could emerge once interest rates and inflation begin to stabilise.

The objective is therefore not simply to become more defensive. It is to remain defensive where risk is poorly rewarded while selectively increasing exposure where markets appear to be pricing in overly pessimistic outcomes.

For clients, this reinforces the importance of diversification, maintaining adequate liquidity and avoiding concentrated exposure to any single economic outcome. Portfolios should be positioned to withstand persistent inflation and elevated interest rates while retaining sufficient growth exposure to participate when market leadership eventually broadens.

This report summarises the discussion and views expressed at the Investment Committee meeting. These views are subject to change as economic conditions, market valuations and investment risks evolve and should be considered alongside each client’s objectives, risk profile and financial circumstances.