Investment Perspectives 2023
Executive Summary
2022 was one of the most challenging years ever for investors
The past year was a brutal one for investors. The tightening of monetary policies was not a surprise, but it proved to be far more pronounced and damaging than anticipated for many asset classes. This fast-paced tightening of monetary policies, due to ongoing inflation pressures, and the war in Ukraine were the main drivers for the significant weakness of markets. China’s zero-COVID policy provided another headwind as its economy fared much worse than forecast. In a risk-off environment, there was hardly anywhere to hide, and this was reflected by the dreadful performance of US Treasuries, considered to be amongst the safest of assets. Volatility in the bond markets reached crisis levels and remained very elevated for most of the year. This stress spilled over to the other asset classes, and the high level of correlation between equities and bonds meant that diversification failed to protect well against portfolio losses.
The breath-taking speed of the Federal Reserve’s monetary policy tightening
2022 will be remembered as the year when the era of extremely accommodative monetary policies finally came to an end. Since the great financial crisis, the major central banks had lowered interest rates to zero, or even into negative territory. Investors had been expecting interest rates to rise and central banks’ balance sheets to contract in 2022, but they were not prepared for what took place effectively. The Federal Reserve’s shift from a very accommodative monetary policy to a very restrictive one took place in a matter of months only, as the size of rate increases quickly rose from 0.25% in March to 0.75% at four consecutive FOMC meetings between June and November. The US central bank hiked its rates by a total of 4.25% in 2022 to a range of 4.25% to 4.50%, with other major central banks taking a similar path, even if not at the same pace. The latest interest rate decisions and communications from the main central banks have confirmed their hawkish stance and determination to bring down inflation.
Investors will remain focused on inflation trends and geopolitics
GDP growth is expected to slow in 2023, with a high risk that the global economy could slide into recession as growth expectations for the United States and Europe are very low or negative. Much will depend on the pace of deceleration of inflation and the trajectory of interest rate increases. The task of central banks around the world is extremely challenging and the risks of a damaging policy mistake are much higher than average. Economic prospects could be boosted if China finally manages to reopen its economy successfully. Geopolitical threats remain elevated. There are many sources of tensions across the world, but one cannot exclude the possibility of some unexpected positive developments even if we are not holding our breath.
Amid elevated uncertainty we maintain a cautious asset allocation
The tightening of monetary policies has erased some of the markets’ distortions and excesses of the previous years, meaning that fundamentals should matter more now that the era of easy money has come to an end. Valuations have improved for most asset classes, but uncertainty remains prevalent on many issues. Despite last year’s derating, equities still face headwinds. That largely explains why we have maintained our overweight allocation to alternative strategies and have increased our fixed income exposure recently in view of its improved risk/return profile.
Table of contents
- EXECUTIVE SUMMARY
- 2022: REVIEW OF OUR INVESTMENT THEMES
- 2022: ECONOMIC & POLITICAL DEVELOPMENTS
- 2022: THE FINANCIAL MARKETS
- 2023: ECONOMIC OUTLOOK
- 2023: FINANCIAL MARKETS' OUTLOOK
- 2023: ASSET ALLOCATION
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Investment Perspectives 2022 | Mid Year review & Outlook
Executive Summary
The economy is facing a sharp slowdown, and visibility is poor
The world economy is slowing down, and early-year GDP growth forecasts have been downgraded materially. The war in Ukraine, lockdowns in China, supply-chain disruptions, and restrictive monetary policies have hurt economic activity severely and hopes for the extension of a strong post-COVID recovery period have been crushed. Russia’s invasion of Ukraine has exacerbated ongoing strains from the pandemic, such as supply chain bottlenecks and significant increases in the price of many commodities. Inflation pressures have also proved to be much more persistent than those forecasted by central banks. The World Bank now expects global growth to reach only 2.9% for the whole of 2022, from a 4.1% projection six months ago. The economy has had to face even more headwinds than expected so far this year and recession risks have kept on rising.
Financial conditions will continue to tighten
The recent period has seen a most dramatic hawkish shift from central banks. Markets are now anticipating the most aggressive and synchronised tightening cycle since the Volcker era of the early 1980s. It has taken some time for central banks to realize how wrong their inflation forecasts had been, and they are now in catch-up mode. The yields of G-7 sovereign bonds have increased at an unprecedented pace. A rise of yields had been anticipated but the speed at which central banks, especially the Fed, have shifted their monetary policies has shocked the markets. In January, markets were expecting three 0.25% rate hikes only by the Fed in 2022 to a level of 0.75%. A month later, five hikes had been discounted, to a level of 1.25%, and by March this expected level had moved up to 2.5%! Current expectations are for the Fed funds rate to end 2022 close to 3.5% and for the terminal rate to reach 4% in 2023. Rate hike expectations from the ECB have also increased significantly, from none expected in January to five at the time of writing to an end-2022 level of around 1%.
The second half will likely remain volatile for financial markets
The first half of 2022 has been brutal for global equity and bond markets. Despite solid 1Q corporate earnings and, so far at least, an overall positive outlook on future profits, equities have dropped significantly because of the rising hawkishness of the major central banks. The combination of higher earnings and lower equity prices means that the derating of valuations, a trend observed since the end of 2020, has continued throughout 2022. Sovereign debt yields have risen at an accelerated pace and credit spreads have widened significantly. Key broad bond indices are down by around 15%, a staggering drop for the asset class. Investors have had to continuously adjust their expectations relative to the policies of the major central banks, which has triggered outsized volatility. In view of the elevated level of uncertainty, due to economic and geopolitical headwinds, we expect financial markets to remain volatile in the near term.
The positioning of the portfolios has become more defensive
Our portfolio positioning has become more defensive, with a neutral allocation towards equities, an overweight in alternative strategies and a fixed-income allocation which is underweight and has a low level of duration. For non-USD denominated portfolios, the US dollar position was also increased, a defensive move. Our equity exposure remains well diversified and some growth equity strategies have been replaced by more defensive ones, a switch that has worked well so far. Our assessment is that a lot of negative news has already been priced in, and market sentiment has become overly depressed. In the current market conditions, the more defensive strategies, including the less cyclically exposed companies, real assets, healthcare, value equities, and quality growth businesses, are likely to continue outperforming. We also like the decorrelation offered by equities of frontier markets, especially as their valuations remain very compelling. In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.
Table of contents
- EXECUTIVE SUMMARY
- THE MACRO ENVIRONMENT
- FINANCIAL CONDITIONS
- FINANCIAL MARKETS
- MARKETS' OUTLOOK
- ASSET ALLOCATION 2nd HALF 2022
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Investment Perspectives 2022
Executive Summary
2021 was another positive year for risk assets
2021 was less stressful for investors than 2020, but it was an eventful year, nevertheless. Markets proved to be resilient, overall, and trends were quite entrenched. The different asset classes behaved mostly as we had expected, with equity markets moving higher, credit spreads tightening, and bond yields rising. The appreciation of the US dollar was more of a surprise, as was the severe underperformance of emerging markets, in large part due to heavy-handed regulatory interventions in China and political issues in Latin America.
The growth of corporate earnings was even stronger than forecasted. This growth drove equity prices much higher in developed markets, accompanied by a compression of valuations. As in 2020, rotations between investment styles and sectors were much in evidence, with the initial outperformance of value stocks being gradually clawed back. The above-average gains of the US mega-caps was also striking, making it difficult for active managers to beat the returns of indexes.
Central banks are facing serious challenges
Central bankers will be put to the test in the year ahead. They will need to find the right balance between their fight against inflation pressures, which they have underestimated, and the risk of withdrawing liquidity too quickly. Their task will not be made easier in view of the unpredictable evolution of the pandemic. The Federal Reserve has been more forthright than the European Central Bank in regard of its plan to unwind its asset purchase program and to raise interest rates thereafter. Following the projected end of its tapering in March, the Fed will then have to decide when to start hiking the fed fund rate. Current expectations are for this rate to be raised three times by 0.25% in 2022 from the current target rate of 0%-0.25%. The Fed’s communication has contributed to contain market volatility, at least so far, but a policy mistake could easily derail the prevailing positive market sentiment and trigger a correction of asset prices.
Markets are likely to look beyond the threat of new COVID-19 variants
The global economy is projected to grow 4.9 percent in 2022, according to the IMF, a growth rate which remains above average as the recovery continues. Recurring coronavirus outbreaks have created stop-and-start economies and governments worldwide will be hoping for a smoother recovery in the year ahead. This would contribute to resolve some of the ongoing supply chain bottlenecks. Each time new COVID-19 variants were found, capital markets recovered very quickly from brief periods of higher volatility. This behaviour of markets should persist, especially if new strains were to prove increasingly less virulent, as is the case with Omicron.
We still favour equities despite their smaller appreciation potential
We expect equities to be the main contributors to the performance of portfolios in the year ahead. Global earnings are forecasted to grow by 10% to 15% and they will be the main driver for the equity asset class as valuations are not expected to expand from the current levels. We anticipate more modest returns for the portfolios in 2022. Equities are unlikely to match their performances of 2021, whereas the environment will remain challenging for fixed income assets as key central banks tighten their policies to fight against elevated inflation pressures.
Table of contents
- EXECUTIVE SUMMARY
- 2021: REVIEW OF OUR INVESTMENT THEMES
- 2021: ECONOMIC & POLITICAL DEVELOPMENTS
- 2021: THE FINANCIAL MARKETS
- 2022: ECONOMIC OUTLOOK
- 2022: FINANCIAL MARKETS' OUTLOOK
- 2022: ASSET ALLOCATION