A new regime has come to pass, and we expect more changes as this matures over the course of the year.
Inflation is likely to linger at higher levels but recede over time. This above‑target inflation means that many central banks may well have to keep interest rates elevated for a prolonged time. However, while a pivot to monetary easing may be elusive, this tightening cycle is nearing its peak. The global economy is likely to continue to slow down. It is yet unclear whether major economies will slip into recession or manage to avoid it.
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Furthermore, concerns such as the ongoing war between Russia and Ukraine, the political polarisation in the US ahead of next year's presidential election and stress in the banking sector will continue to have a major impact on sentiment and the direction of the markets.
As we look forward to the remainder of 2023 and beyond, our multi‑asset solutions team has identified a range of ideas to help steer investor portfolios through the uncertain period ahead.
Theme 1: inconsistent inflation
After surging to multi‑decade highs in 2022, inflation is likely to recede erratically over the course of the year.
In positioning for disinflation, investors can look to balance assets that should fare well in a disinflationary environment with those that do not perform too badly if inflation continues. An example here is the mixing of value and growth equities, both regionally and globally.
Investors can also look to maintain inflation hedges, which means holding assets that should fare well in an inflationary environment but do not perform too badly if inflation falls. Examples include natural resources equities and REITs, as well as shorter‑duration, high‑yielding fixed income.
Theme 2: elusive easing
While monetary policy tightness is likely to peak this year, a pivot to easing may elude markets. With yields at the most attractive levels in years, global bond diversification could be advantageous if policy eases at different speeds across the world.
Diversified, flexible bond strategies could be poised to capitalise. Maintaining liquidity in portfolios could also be an edge, in a volatile environment where central banks are selling bond holdings. This may increase the appeal of liquid alternatives, such as multi‑asset total return strategies.
Theme 3: recession reservations
A recession this year remains a risk, but also an opportunity. In preparing for a recession, investors could seek out global government bonds with long, high‑quality duration - as well as defensive equity sectors like utilities, healthcare and consumer staples.
It is important to remember a recession is not necessarily bad news unless something systemic breaks down. Stock markets tend to rally mid‑recession, pricing in the eventual recovery. Companies able to survive can come out stronger. Nimble asset allocation is key.
Theme 4: unending uncertainty
Geopolitical events, increasingly polarised politics and continuous change will continue to create uncertainty.
After failing to diversify portfolios recently, government bonds may become a diversifier of equity risk again as we move forward. However, investors should rely on more than a single diversifier.
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Therefore, in addition to high‑quality global government bonds, investors could look to safe‑haven currencies like the US dollar, Japanese yen and Swiss franc, as well as liquid alternatives and other defensive strategies.
In addition, China could once again be in the spotlight. Chinese assets have lagged since the pandemic as the impacts of lockdowns were felt. Today, China has the potential to boost not just its own economy, but countries throughout the region.
Theme 5: new normality
After more than a decade of negative bond yields and cash interest rates at zero, we are getting back to reality.
Change, and more reasonable valuations, mean opportunities for long‑term investors. Investing when valuations are reasonable has translated in the past to higher long‑term returns.
Examples here include small‑cap equities and European corporate bonds. ESG and impact is another area set to return to the spotlight, as the transition to sustainable energy gains pace. Sustainable and ESG‑aware strategies, as well as impact vehicles, are likely to benefit.
Finally, each decade has seen the largest companies in the world change. This decade is not likely to be different. Disruption is ever-present. Investors who identify the trends and surf the wind of change can benefit from emerging opportunities.
Global equity strategies with a focus on innovation and being on the right side of change are best placed to capitalise, as are emerging market and frontier market equity portfolios.
Yoram Lustig is head of multi-asset solutions, EMEA, at T. Rowe Price