A very busy six months
The first half of 2023 may have felt challenging, but it’s fair to say that the global economy and financial markets have shown to be more resilient than expected. Generally speaking, stocks and the fixed-income market have delivered positive returns year to date.1
While breadth of the positive performance in the stock market isn’t as broad as we would have liked—for instance, small caps and parts of the emerging-market universe didn’t do too well—technology stocks managed to carve out some respectable gains after a horrible 2022.
On the fixed-income side of the equation, we’ve seen positive returns in government-backed and credit securities. Those returns may seem modest, but they do represent a sharp improvement from what we saw in 2022.
Looking ahead, we find ourselves focusing on three key themes from an asset allocation perspective.
1 Dial down the focus on inflation, worry more about growth
The battle against inflation isn’t over, but it’s time to cast our gaze further afield and focus on growth—specifically, the effect that sticky inflation and cumulative rate hikes can have on growth. The lagged effects of central bank monetary tightening are finally becoming more observable, and it’s becoming clear that they’re starting to bite into growth dynamics. While the economy has been fairly resilient, we think it isn’t enough to avert a recession in parts of the world.
That said, it must be noted that we’re less worried about how deep the expected recession could be than we are about how long it will last. It’s possible that we could be stuck in a slow-growth environment for a prolonged period—a scenario that isn’t reflected in current pricing of market securities.
2 Certainty about rising uncertainty
Investors should get used to heightened uncertainty because it’s unlikely to go anywhere anytime soon. In addition to ongoing uncertainty around central bank policy, markets will also need to constantly adjust to the ever-evolving global geopolitical backdrop. Crucially, markets seem to have a fairly rosy view of corporate earnings, which seems somewhat optimistic—in our view—relative to what fundamentals suggest. In such an environment, we believe it makes sense to focus on higher-quality assets and adopt a more defensive positioning.
3 An improvement in long-term return prospects
Our analysis indicates that the longer-term return prospects for equities and fixed-income assets look healthy once we’ve returned to a growth environment, which is particularly true for fixed-income assets.
On the back of the sizable reset in interest rates across the globe, the return prospects for fixed-income instruments now look much better over a 5- to 10-year forecast horizon relative to where they were just two years ago. As active managers, we’ve been able to identify interesting opportunities within the fixed-income complex.
Broadly speaking, stock valuations have fallen from their recent peak; however, the repricing that equities went through wasn’t as severe as their fixed-income peers. Relatively speaking, while there are opportunities to be found within the equities space, we find fixed income more attractive at this juncture. Investors can expect fixed-income instruments to continue to provide a return in a low-growth environment; the same can’t be said of equities, as a protracted period of anemic growth typically translates into headwinds for this asset class.
“Crucially, markets seem to have a fairly rosy view of corporate earnings, which seems somewhat optimistic—in our view—relative to what fundamentals suggest.”
Looking beyond short-term challenges
In a time in which instant gratification has become the default setting, it can be difficult to battle short-termism; investing, however, requires us all to discard the instinct to assess everything through the prism of now—it’s a longer-term commitment. Things should improve once we get past the imminent low-growth environment and likely recession. For the next 6 to 12 months, adopting a more defensive posture with a keen focus on quality could make the most sense, particularly within the context of rising uncertainty.
1 As of 6/13/2023.
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