A rebalancing act

Julien Lafargue, London UK, Chief Market Strategist

  • This year has been a tough one for investors, with challenging conditions encountered across most asset types
  • Global growth is likely to continue to slow into 2023 as more countries fall into recession, even if shallow, leaving central banks needing to balance tighter monetary policy against economic growth
  • Market volatility during a slowdown is to be expected – especially in equities. As interest rates climb, fixed income could become interesting again
  • Above all, investors should beware being too pessimistic. Selectivity and composure, as well as a long-term and diversified strategy, could help navigate any uncertainties. All recessions bring pain, but not all are long-lasting or deep

2023 looks like being another difficult one for investors. At a time of slowing growth, sky-high inflation, and punchy interest rates, investors and the authorities will need to tread carefully. That said, new investment opportunities have emerged, keeping us constructive over the medium term.

The last twelve months have been tough for investors. Only commodities posted positive real returns at the asset class level, and portfolios made solely of stocks and bonds have had one of their worst calendar years in a century, according to Bloomberg.

Uncomfortably constructive

Looking ahead and into 2023, we remain “uncomfortably constructive”. Indeed, we expect the next 12 months to be equally challenging for investors. The prospect of slowing economic growth, if not recession, coupled with stubbornly elevated inflation, will require central bankers to find the right balance between too much and not enough monetary policy tightening. At the same time, governments won’t be able to pick up the stimulus baton as easily, with funding becoming increasingly expensive.

Both Europe and the UK are more likely than not to enter a recession. In the US, the outlook is slightly more encouraging, but the largest economy in the world may barely grow next year. One big question is whether China will finally move away from its zero-COVID policy to resuscitate the economy.  

But with lower growth and supportive base effects, inflation should finally come down. The pace of this normalisation process is uncertain (see Inflation anchors aweigh). However, it should be somewhat proportional to the deceleration in economic momentum, assuming that geopolitics don’t get in the way. We anticipate that both growth and inflation will moderate, rather than collapse, next year.

This backdrop is likely to lead to significant volatility and, at one point or another, investors are bound to get caught wrong-footed if they take too strong of a directional bet. With little sign that this period of heightened volatility is over, appropriate diversification (see Is asset allocation at a tipping point?) and a focus on your long-term objectives (see Being comfortable with being uncomfortable) remain essential.

A new era for bonds

In our last Outlook, we made the case that investors should be looking beyond traditional stocks and bonds portfolios. Our main message now is that it may be time to revisit (and possibly rebalance) their bond exposure. We continue to see attractive prospects for real assets and private markets, but, given the repricing in fixed income markets, we believe investors should look again at this part of their portfolio in particular. The risk-free rate — which had become the rate-free risk in the last decade — is finally back, and investors can now generate attractive income in the public debt markets.

This repricing in rates hasn’t happened in a vacuum, and equity valuations too have sold off. Here, we expect markets to remain choppy until more clarity emerges on the earnings front in particular. While equities have been the only game in town for several years, this is no longer the case and bonds are now a credible alternative (or at least complement) in portfolios. As we pointed out previously, over the medium to long term, we continue to see more upside in stocks than in bonds, but 2023 could be a more mixed year.

Energy transition

Finally, the last year has highlighted why countries need to secure access to reliable sources of energy. In this context, we are convinced that the energy transition to a low-carbon world will accelerate in 2023 and beyond, presenting investors with many opportunities.

Beware being too pessimistic

Next year will be a difficult but necessary rebalancing act for central banks, governments, markets, and investors alike. But, amid all the pessimism and concerns, we see more opportunities today than at any point in the last few years.

Our messages for 2023

  • A recession in Europe, the UK, and possibly the US is more likely that not.
  • Fixed income is interesting again.
  • Volatility isn't going away.
  • Selectivity and composure will be key to navigate an uncertain environment.

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