THREE uncertainties that were the hallmarks of a challenging investment backdrop in 2022 look set to find clarity this year, to a large degree. These are the trajectory of interest rates; inflation; and the severity of an economic recession in major economies.
Following tamer inflation data in the US for December, the US Federal Reserve raised its benchmark rate by 25 basis points last week. While markets cheered this development, some strategists at private banks and asset management firms remain cautious. Most have called for an underweight in equities.
JP Morgan chair of global research Joyce Chang says: “We see the Fed going forward with another 25 basis points at the next meeting and then pausing. But a pause is not a pivot. I think the market is being very premature in pricing in a pivot … Inflation is not out of the woods yet, even though we’ve seen a big disinflation trend. I do think the Fed will stay on hold, because inflation will still be well above the 2 per cent target where they’re comfortable.’’
Patricia Quek, head of wealth management (Singapore) at UBS Global Wealth Management, reckons a more favourable backdrop for markets should emerge as the year progresses. “Investors sheltering from volatility will likely need to plan when and how to head back into riskier assets… As the year evolves, growth equities and riskier credits should turn more attractive once conditions are in place for inflation to fall sustainably towards 2 per cent and for the Fed to consider looser policy.’’
The good news is that the worst of interest rate hikes appears to be over, even as markets debate when exactly rate cuts might ensue. Here are some key themes for 2023 and how investors may position themselves.
Overweight fixed income
Steve Brice, chief investment officer of Standard Chartered Bank’s wealth management unit, sees today’s bond yields as one of the best opportunities of 2023. “We expect the Fed to reach the peak of its current hiking cycle in H1 2023. In our view this has created an attractive opportunity to lock in an attractive long-term yield.’’ He has an overweight call on bonds.
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M&G Investments in a January commentary said credits have become attractive, as investors are well paid to take risk and the risk-reward dynamics have become compelling. “Defaults are expected to stay low due to strong company fundamentals and robust balance sheets, while many businesses have taken the opportunity to refinance their debt for several years at cheap levels.’’ At end-2022, credit spreads reflected an implied default rate well in excess, not only of average default rates, but also of the worst default rates, it said.
JP Morgan’s Chang says investing in US high-grade credits could earn 7 to 8 per cent. “We don’t think you necessarily need to move into the higher yielding markets where we see more spread widening occurring… Corporate balance sheets in the US for investment-grade companies still look very strong.’’ There has been some US$160 billion worth of “rising stars’’ or issues upgraded from non-investment grade to investment grade. And “fallen angels’’ or issues downgraded to non-investment grade comprised US$15 billion. “We think credit quality continues to be resilient, and fixed income returns are much higher than they were in the past.’’
Positive on China and Asia
UBS has lifted China to “most preferred’’ in its Asia strategy. The bank favours sectors that are seen to benefit from reopening, such as pharma and medical equipment, Internet, capital goods and materials. The reopening is also a positive for Asia investment-grade and selected high-yield bonds. “We believe Asian assets are likely to continue their rebound. We expect equities to lead the way higher with valuations at crisis levels and a trough in the tech and trade cycles in sight,’’ says Quek.
China is a bright spot in the global economy, says Christopher Wong, Fidelity International South-east Asia portfolio strategist. “China’s recovery is expected to be supported by domestic consumption which is set to recover from a very low base, increasingly accommodative policy in the form of higher investments in targeted sectors, and potentially more easing from the PBOC.’’
Wellington Management multi-asset strategist Nick Samouilhan says it is key for investors to manage their exposures in the first quarter as there is still significant uncertainty around the path for inflation, growth, interest rates and China’s reopening. “It will require investors to go long on equities and bonds, and switch from the US to China. We expect China’s reopening to gain meaningful momentum at some point this year as consumption levels resume.’’
Steven Fong, Credit Suisse head of mandate solutions (Apac), says: “We are not in a hurry to own more equities in discretionary portfolios, except for the case of Chinese equities, where we expect rates to stay low and may even go slightly lower this year, as they reopen and shift focus back to their economy.’’
Stay defensive for now
Strategists agree that investing in defensive, quality assets is key to navigating the near term. Bhaskar Laxminarayan, Bank Julius Baer’s CIO, says: “As the macroeconomic environment is not particularly favourable for growth this year, quality investments become more valuable. Risky assets may not offer adequate compensation for the additional risk that investors have to bear. Hence, it’s important to stick with strong businesses with high free cash flow, and avoid the more speculative, unprofitable names.’’
Wellington’s Samouilhan suggests some ways to cope with elevated volatility. These include stepping up the search for “dependable’’ income – that is, flexible and well diversified sources of investment income; and investing in enduring structural changes.
Credit Suisse’s Fong advises diversification. “Some investors may feel that diversification does not seem to work since market correlations tend to be high during drawdowns. But these periods don’t last long, and over time, spreading investment risks means less volatility, which leads to greater ‘resistance’ to behavioural biases that could cause investors to buy high and sell low.’’
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