This CIO thinks we've hit "peak inflation". Here is how he's investing.

Hans Lee

Livewire Markets

2022 has been the year of inflation - and more recently, the potential end of its relentless rise. The Reserve Bank expects inflation to top out at 8% in the current quarter, with economists predicting a pause sometime in the first half of next year. Meanwhile, in London, Bank of England governor Andrew Bailey just revealed it will have to hike into a recession - and a two-year-long recession is its new base case. 

Given this backdrop, it may surprise you to know that at least one global CIO - based in London normally, no less - is actually adding to positions in global equities and bonds. Why?

Because he believes the inflation spike is finally going to retreat into the distance.

Recently, I sat down with Moz Afzal, the man making this contrarian call, for an extended conversation. Afzal is the Chief Investment Officer at EFG Asset Management, a position he has held for the best part of 20 years. Before EFG, he spent several years in the British Treasury at the same time when George Soros broke the Bank of England.

Read on to learn more about his asset allocation calls and how feels about the Australian opportunity relative to its global peers. 

Afzal's Key Calls

  • Inflation's key headwinds to recede next year
  • Investing for a Fed pivot - including a current tactical overweight to equities
  • APAC (including Japan) and North America are the best regions
  • High-yield credit and some government bonds look attractive
  • Overweight AUD and GBP assets
  • Emerging market assets are finally looking good

On central bank mistakes - and will they make another?

Given Afzal's regular home, we had to begin by asking him about the financial and political tumult of recent months. But when asked about the Bank of England specifically, he argued its problems started 12 months ago when the committee failed to follow through on its forward guidance.

"The problem started 12 months ago with poor communication," Afzal says. 

"Governor [Andrew] Bailey basically told the markets that it would be the first to raise interest rates. When it came to actually raising interest rates, it didn't. The Pound started to roll off, and [investors] lost confidence in the Bank of England."

The missteps that followed created a scenario where the Bank of England went from "in front" of the rate hiking cycle to drastically behind it. And many investors, including Afzal, argue that a second big mistake (hiking interest rates more than necessary) is still a possibility.

"[Overtightening] is a big risk for markets," Afzal says. "There's a strong chance of that here, and money markets are already starting to price that in. The question is how much they cut."

Why will inflation retreat next year?

Afzal tells me "inflation" and "recession" are still the two most asked questions by EFG's clients, but he says there is reason to believe the peak has passed even if services inflation will likely remain stubborn.

"Shipping freight rates, semiconductors, and supply chains are all starting to come off, as well as commodity prices which have come off 30-40% since March. That gives us a lot of confidence at least one side of the equation is going to be deflationary or disinflationary," Afzal says. 

"Inflation will hang around 3%, rather than the 6-8%, where it's at the moment."

So does that gift central banks that long-savoured "soft landing"? Afzal argues the answer is more nuanced than that. 

"Somewhere between a soft and hard is our view," Afzal says. "Markets are priced for a soft landing but are worrying about a hard landing."

Preparing for the pivot

With US$50 billion in assets under management, most of whom are private clients or institutional investors, Afzal is not frying with small fish. 

On equities, Afzal is much more active given his new base case.

"We're increasing our equity allocations for a Federal Reserve pivot. We are preparing for that," Afzal admits. "We've also been focusing a lot on UK and European equities, rather than just going straight to big tech in the US."

Some of his top sector bets in recent times include consumer discretionary, housing and industrial companies. 

But Afzal has been around long enough in markets to know not all predictions go to plan. As a backup, the portfolio has a heavy bias towards value plays like its large overweight in healthcare stocks. By region, EFG also has a strong preference for Japanese equities due to the recent reopening and depressed Yen.  

There's one other economy in the Asia-Pacific region that Afzal is constructive on - Australia. While it's not the largest overweight in his global portfolio, there are two key factors global investors like him are watching out for.

"First of all, if the Fed pivots, it naturally means the Australian dollar could strengthen," Afzal says. "But if China comes out of zero COVID and some economies have powerful reflexes on China's reopening then you've got to feel pretty positive."

In the bond market, it's all about finding where the quality yields are. 

"We've been increasing our high quality fixed income allocation - investment grade has been where we've been leaning into over this period," Afzal says. 

"It's been a relatively straightforward position," Afzal adds, referring to the fact yields on some products have not been this high since before the Global Financial Crisis of 2008. "Investment-grade spreads are in the top 25% of the historical range over the last 20 years. That gives us a little bit of confidence that a lot of bad news economic slowdown's already priced in."

Can the value over growth trade run even further?

This, in Afzal's view, is the real billion-dollar question. The short answer is that value's run can continue so long as the market continues to put faith in a soft landing. 

"For value, there's a bit of a sweet spot for the next six to nine months," Afzal says. 

"But if it goes to a hard landing and the Fed has to cut rates, then you would have to pivot back to growth equities."

And finally... the big contrarian call

I ended our interview with a question that I will be continuing to ask all our fund managers and market experts through the next few months:

What is your highest conviction call for 2023?

Afzal's answer was to look at buying emerging market equities and bonds - but not China. 

"We're positive on China, Latin America, Middle East, and South America," Afzal notes. "A lot of these countries were very early to raise their interest rates way back in 2021. Their inflation is already coming down."

As those rates peak and start to come down again, Afzal says this will be priced quickly into valuations in those markets. Although it's historically unusual, those unusual opportunities are presenting now. 


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Hans Lee
Content Editor
Livewire Markets

Hans is one of Livewire's content editors. He created Signal or Noise and helps write the LW-MI Morning Wrap. Previously, he was the market open producer at ausbiz TV and wrote for Bloomberg, Reuters, and The Australian.

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