With stock markets at all time highs, the outlook is being complicated by “fading policy support, higher rates, elevated inflation, and potential tax increases”, fund manager T.Rowe Price says.

US small caps and emerging market (EM) stock indexes are where it’s looking, as the global economy tracks a non-linear path out of the pandemic.

The group’s domestic investment team have grown “more cautious” on Aussie equities, with gains in the current FY21 reporting season representing a possible high-water mark.

“While still benefiting from the global recovery in the short term, Australian shares might not outperform global shares for long,” T.Rowe Price said in its August report.

‘Curb your enthusiasm’ (T.Rowe Price edition)

The investment firm’s August update follows on from its July report, where it set out the lay of the land for the financial year ahead.

The analysts cited a balancing act playing out; on the one hand the broader recovery is still in play, with plenty of pent-up demand from households and consumers.

On the other hand, valuations look stretched. Stocks are already at record highs, and the first signs are starting to trickle through that “ultra-easy environment is changing quickly and may lead to more volatility ahead”.

As a result, investors “may need to curb their enthusiasm for equity returns going forward”.

Value climbs off the mat (again)

Heading into the start of this year, the stage was set for value stocks to make a comeback after “lagging growth stocks for over 15 years”, T.Rowe Price said.

Global economic growth was rebounding, and yields were climbing on expectations for a new wave of pent-up demand and rising inflation.

Just as quickly, rates fell back. Inflation is climbing through the middle of the year, but markets have so far taken the view it will prove transitory.

Now, global complications stemming from the Delta variant have added another layer of uncertainty to the economic recovery — particularly in Australia.

However, “the story for value may not be over just yet”, T.Rowe Price says.

Major economies haven’t fallen off a cliff, and supply/demand imbalances such as the ongoing global shipping crisis are helping to keep inflation “stubbornly high”.

“With the hopeful containment of the Delta variant and increasing regulatory pressure on growth stocks, investors may start betting on value pulling off a double-reversal this cycle,” the analysts said.

More broadly though, the T.Rowe Price fund maintained its July portfolio structure in August, with a slight underweighting of equities relative to bonds and cash.

“Smaller companies should still benefit most from unleashed pent-up demand and fiscal stimulus,” the analysts said.

However, “valuations have become challenging so focus on idiosyncratic opportunities”.