Even though interest rates rise this week, either in Australia (an even money call) or the US (probably) investors won’t be changing their fixation on value, which has been behind Blue Chip Value Portfolio’s outperformance. Value refers to investments that have more certainty both in terms of income and growth. There is less risk and you’re not factoring in much, if any, blue sky. One of our long-term favourites is emblematic of our strategy: Telstra (ASX:TLS).

Telstra has hit multi-year highs as investors gain confidence that the business will achieve growth amid increasing economic uncertainty. The moves justifies our positive stance with Buy recommendations over many months and years. The stock has returned 12% a year since we first tipped it five years ago and 18% a year in the past three years. We cover the stock this week to give subscribers our advice on whether to buy (more) hold or sell.

We also cover another favourite, the giant Rio Tinto (ASX:RIO), in which the Portfolio is also overweight. The stock has delivered over 18% a year for the past three years and we look closely at the iron ore price, which is the big driver, on top of its growth potential in copper.

We appreciate that times are difficult, but stocks like these really do provide ballast for any portfolio. This gives you the chance to take some risks on Small Caps.

What's Happening in the Broader Market?

Having said that, it does pay to keep an eye on the bigger picture, especially since there have been big moves both in the giant bonds market; as well as in the structure of our own Reserve Bank of Australia. Perspective, as always, is needed.

As mentioned above, the odds are favourable for the US Federal Reserve to increase the benchmark federal-funds rate by 0.25 percentage points to 5.00- 5.25% next week. Meanwhile the odds are even for the RBA to increase or not, our own rate by that magnitude to 3.85%.

What's the big driver?

Inflation, which in both markets remains stubbornly high, albeit at lower levels than late last year. The rate of inflation in Australia, released this week, eased to 7% in the year to March, down from its 31 year high late last year of 7.8%.

Prior to this data being released, Australia’s Treasurer Jim Chalmers announced a seismic shift in the structure of the RBA, separating monetary policy decisions from the central bank’s administration.

This partly reflects the desire to broaden the RBA’s experience away from its current focus on business; but it also reflects the bank’s failure since to end of the pandemic to achieve its remit of controlling inflation to within a 2-3% band, alongside full employment.

This is not unique, but the smoking gun came with the combination of missing the target range for some years, on top of the statement by the RBA governor in early 2021 that the expected the cash rate was to remain at 0.1% until at least 2024; the culprit ultimately being the decision making process that allowed the statement to be made, which seems to be a type of groupthink.

What needs to change?

Yes, diversity is important, but changing the composition of the board won’t simply lead to it abandoning antiquated notions such as the Phillips curve economic model, which predicts the correlation between reducing unemployment and increasing wage rates, leading to inflation. This has obviously not been the historical experience of the past 20 years. In short, there needs to be more independent thinking of economics to confront entrenched RBA notions.

Whatever happens, we are stuck with an economy growing, in nominal GDP terms, at 5% ahead of business as usual conditions, which assumes the pandemic hadn’t happened. In other words aggregate demand (nominal GDP) is at levels 5% above aggregate supply. In order for inflation to be curbed, this 5% gap needs to be suppressed, because supply cannot simply be ratcheted up in the short-term.

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What does this mean for investors?

What is encouraging is that the big money in the bonds market has been buying at the long end. Australian 10 year government bond yields have declined from just over 4% at the end of last year to 3.35%; while US 10 year Treasury bond yields have declined from 4% in February to 3.50%. As inflation wanes, markets are saying that economic growth will slow, but we’re not heading for what economists call a “hard landing”. All this is premised on unemployment, which in both markets is close to 3.5%, a historically low level and the key metric to watch.We give you the best of the big four banks in Australia to buy with our favourite stock.

This market is going to be a challenge for discretionary retail, such as Harvey Norman (ASX:HVN) and JB Hi-Fi (ASX:JBH), which data shows is coming under pressure at the all-important sales line. Australia’s big banks – CBA, NAB, WBC, ANZ– remain well positioned and are good value, which is why we are still overweight.

To read what we think on the banks click here

We remain bullish on the big resources stocks – BHP, RIO, S32 – because they are low cost producers and the global economy is still chugging along. The best value we are seeing is in Small Caps, which provides your portfolio with the growth potential you need to confront life’s expenses down the track.