This note summarises our midyear investment outlook. These developments may not mean changes to your portfolio, so please contact your Client Advisor for the latest update on your portfolio. Comments on recent performance are not indicative of future performance.
Macro Outlook
- At the beginning of 2023, we expected three key shifts to play out during the year. The so-called “three Ps” are: a peak in inflation and then a moderation (in the US before the Eurozone and, lastly, the UK), a pause in central banks’ interest rate rises (first the US Federal Reserve (Fed), then the European Central Bank followed by the Bank of England), and a pick-up in China’s economic growth following reopening and stimulus.
- To different degrees, these shifts are already happening and we expect them to continue. As such, the second half of 2023 should begin to unveil a new market cycle that’s likely to be very different from the low inflation and interest rate environment of the 10-15 years prior to the pandemic.
- Inflation is moderating. This has been most evident in the US and to a lesser extent in the Eurozone, while the UK still has a long way to go. We think inflation across the three economies will likely remain above the 2% target for quite some time. This means that central banks will likely keep interest rates in restrictive territory throughout 2023, in contrast with market expectations of lower interest rates. While there could certainly be a one more rate increase in the US, we expect the Fed to leave rates unchanged for the rest of the year. A few more rate increases in the Eurozone and the UK seem probable. But, as growth slows in the West, we think a reduction in interest rates is likely in 2024.
- A shallow recession is still likely in the US. Contrary to our initial expectations, both the Eurozone and the UK appear to have avoided an outright recession, although their rate of economic growth remains weak.
- In the East, China, Japan and other Asia-Pacific countries reopened far later after the pandemic than those in the West. Despite an uneven recovery and some setbacks, we think they have more room to rebound and normalise as reopening progresses and stimulus filters through.
Asset allocation & flagship portfolio implications
- As we head into the second half of 2023, we maintain our defensive positioning from a tactical point of view. In other words, we think the lagged impact of central bank policy and tightening credit standards are likely to put downward pressure on economic activity and company earnings. This leads us to believe that the upside for risky assets – such as equities – is limited. We therefore maintain our slightly reduced exposure to credit and equity markets, along with our increased exposure to high-quality government bonds such as US Treasuries.
- In addition, we increase our exposure to US investment-grade bonds, which should benefit from peaking interest rates. At the same time, we maintain our reduced exposure to riskier, high-yield bonds in the US, as our recession outlook implies rising default rates.
- We’re positive in the long-term on US equities given a diverse sector exposure, deep capital markets and a strong ability to scale innovation. Our single-stock portfolio is skewed towards the US, with a bias towards quality investments and larger companies.
- That said, we’ve taken profits in less attractively-valued tech companies that have performed well in 2023. And we’ve reduced our tactical US equity exposure to slightly less than normal, given unattractive valuations as well as poor economic and earnings prospects in the near term. Within our US equity allocation, we hold defensive investment styles ranging from quality dividend payers to stocks with low volatility.
- In Europe, as the economy appears to be avoiding the sharp recession we previously expected, we marginally add back some equity exposure by purchasing pan-European low-volatility equities. These blend the Eurozone – where our exposure remains reduced relative to our long-term allocation – with more defensive markets such as Switzerland and the UK, and more defensive sectors such as health care and consumer staples. Conversely, we reduce our European and UK investment-grade bond exposure as we see risks of further interest rate increases.
- We continue to maintain our exposure and preference for equities in Asia-Pacific including Japan where valuations are attractive and reopening and stimulus offer prospects of an improvement in earnings.
- In lower-risk portfolios for sterling investors, we are further diversifying by adding a new exposure to a variety of hedge funds, which we fund predominantly via reducing gold. We believe this allocation will improve the risk-adjusted returns of portfolios over the long term.
Past performance is not a reliable indicator of future returns.
If you have any questions about our latest market views or portfolios, please speak to your Client Advisor who will be happy to help.
Tactical Asset Allocation
Important Information
Information correct as at 5 June 2023.
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