In a still challenging market environment, patience is required, and investors should stay the course. On the equity side we remain defensively positioned and in the fixed income area we expect positive returns again. In the current market environment, portfolio components with a low correlation to equities and bonds are in high demand.
The investment year 2022 will go down in history books as an outlier year. Record high inflation rates, which climbed to over 10% in some Western economies, had a strong impact not only on equities but also on fixed income. The bond market was unable to live up to its diversification role due to the enormous price pressure. The global equity index MSCI All-Country World ultimately lost 18% last year. The Global Aggregate Index, the benchmark index for global investment grade bonds, also suffered a substantial loss, falling by more than 16%. It is therefore hardly surprising that many investors are already focusing exclusively on the new year. However, 2023 holds the same challenges for investors as the previous year.
The challenges – a very restrictive monetary policy by the G7 central banks and a deterioration in the inflation/growth mix – remain the same at least at the start of the new year. The European Central Bank (ECB) and the Bank of Japan (BoJ) have even tightened their monetary policies recently. Thus, ECB President Christine Lagarde has announced the prospect of reducing the central bank balance sheet (quantitative tightening, QT) in the first quarter of 2023. The BoJ Chairman Haruhiko Kuroda has said that the central bank will slowly but surely abandon yield curve control and allow yields on ten-year Japanese government bonds to rise to 0.5%.
It now remains to be seen how the fastest and steepest tightening cycle since the 1970s will affect US growth. The data signal a massive economic downturn, and a recession in the second half of the year can no longer be ruled out. In the eurozone, the picture has also deteriorated further. Investors currently expect the ECB’s deposit rate to rise above 3.5%, an increase of over 50 basis points from the previous month. The pressure on risk premiums of government bonds of European periphery countries is likely to increase, and with it the pressure on the ECB.
The macroeconomic environment remains challenging, which is already strongly reflected in the positioning of market participants, at least in the short-term. Some indicators, such as the put-call ratio, are at a ten-year high, which corresponds to an extremely bearish positioning and should currently be considered a contraindicator. Seasonality – December through February – is a positive environment for risk assets by historical standards. Despite these two bright spots, the market environment remains challenging for investors in the first half of the year, and we anticipate correspondingly high volatility in capital markets.
In the market and economic environment described on the previous page, we continue to favor bonds over equities at the start of the year. Based on investor positioning, market sentiment and seasonality, a rally in risk assets could start at any time, however, it is too early to strategically increase risks in our view. As long as leading central banks provide headwinds, patience is required. Therefore, it is important to stay the course.
Ahead of the all-important corporate earnings season – starting Mid-January – nervousness on stock markets is high. Annual outlooks and corporate expectations are likely to provide an initial indication of how deep the earnings recession could be this year. It is until this year that the major central bank’s strong monetary tightening will not be evident in the real economy, and thus in corporate balance sheets and income statements. Therefore, it is not the time for experiments in our view, at least on the equity side, and our positioning remains defensive.
After a very difficult year in fixed income, where ten-year US Treasury bonds lost more than 16%, we expect positive returns again this year. As the major central banks are likely to continue to tighten interest rates, an increase in duration is not yet opportune. Volatility is likely to remain high by historical standards, as visibility on monetary policy – especially from the ECB and BoJ – is limited. We continue to favor short-term government bonds and have a clear preference for corporate bonds over high-yield bonds due to issuer risk.
In the current market environment, portfolio components with a low correlation to equities and bonds remain highly favored. Hedge funds as well as liquid alternatives are among our preferred investment options here. Gold belongs in every asset allocation over the long-term. After a rally of over 10%, we are waiting for a setback for further accumulation.