Too Soon to Get Aggressive on Risk: HSBC Asset Management 2023 Investment Outlook
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2023 is going to be the year of the macro cycle says Joe Little, Global Chief Strategist at HSBC Asset Management.
The realities confronting investors in 2023 can be described as 'parallel worlds' - that is to say, different economic trends in different parts of the world, a different economic environment versus what we have become accustomed to in the 2010s, and some big and important shifts in market valuations, which we think really change the game for investors.
Overall, the rapid policy tightening of 2022 has been the main driver for disappointing investment returns.
Looking ahead, we think inflation pressures are now going to ease, progressively.
But inflation should still be persistently high for much of 2023, and on the back of rapid tightening by the Federal Reserve we are forecasting a recession for the US in 2023 - a corporate profits recession in the first half of the year, followed by a GDP recession.
Over the coming months, as economic activity data continues to worsen and inflation cools, a backdrop of weaker demand, diminishing pricing power and sticky wage bills can translate to a more significant-than-expected deterioration in company earnings performance That process of earnings downgrades will probably be a driver of weak equity market performance.
However, a turnaround could follow later in the year amid cooling inflation - aided by weaker labour and housing markets - which means central banks can pause rate hikes, with even the prospect of rate cuts later in the year.
With better visibility on the policy and economic outlook, investor sentiment will recover from rock bottom levels to take advantage of much improved valuations in riskier asset classes such as equities and high-yield corporate bonds.
Scenarios
Our central economic scenario recognises the fact that a US recession in 2023 is looking increasingly likely.
Nevertheless, opportunities will begin to present themselves at a later stage.
Three main variables will determine the 2023 trajectory in markets:
- The Federal Reserve policy tightening
- European energy crisis
- China policy
These issues can drag markets both ways.
If they play out adversely, then the investment outlook would look more like our adverse scenario - a return of what we call a 'global poly-crisis' of rolling economic and market shocks that has plagued markets this year.
It would mean more volatility and more stagflation, a difficult mix for market performance.
Equally, a rapid decline in inflation trends, a mild European winter, and a revived covid immunisation program in China could create a more optimistic situation.
It would mean that the global recession is only relatively mild, and several of the key risks of 2022 have largely played themselves out.
This 'better days' scenario would be a supportive scenario for risk markets.
Market implications
Our 'house view' continues to reflect an overall cautious stance. We do not advocate an aggressive use of risk budgets.
For equities, we think price to earnings ratios in developed markets have scope to fall given where bond yields are.
But the big risk remains corporate earnings downgrades.
Value still makes sense as rates continue to rise, although this needs to be balanced against a deteriorating macro outlook and lower commodity prices. The coming switch in the macro story from stagflation toward recession should favour defensive and quality factors.
In the emerging markets equity space, Asian markets seem attractive in the context of better macro trends and scope for policy easing in China.
Bonds are the natural asset at this point in the economic and market cycle.
We maintain a positive stance on the short-end of the US Treasury curve, preferring European and Asia credits where relative valuations offer a margin-of-safety amid solid corporate balance sheets.
The regime of ‘TINA’ (There is No Alternative) is over but there are credit opportunities with CINDY (corporate indexes now deliver a yield). Overall, we want to be selective and focus on higher quality segments.
There are also some interesting themes in the Alternatives space, notably on defensive parts, like infrastructure equity, and different economic exposures, like natural capital. Strategies like hedge funds – particularly global macro or CTAs – also continue to look like attractive diversifiers for asset allocators.
A new investment strategy playbook to reflect Parallel Worlds
We are ending 2022 with much higher bond yields and lower valuations on credit and equity markets. Consequently, medium-term expected returns across many asset classes are now higher.
Nevertheless, we don’t think that global risk assets have gone through the difficult period. It leaves us with three key pillars in our playbook.
The emphasis on portfolio dynamism
A significant jump in credit yields has changed the equation for portfolios. We favour a selective, regionally-focussed approach. European and emerging credit markets seem particularly interesting. Even though the economic situation is difficult, corporate balance sheets are in good shape, which should be a relative support in the months to come.
The idea of being active in emerging markets
Attractive valuations, a peaking US dollar and China policy support creates opportunity for EMs in 2023. Importantly, dispersion between individual markets in Asia has widened materially, and stock level dispersion is even greater - reaching a point not seen since the global financial crisis of 2008. This offers diversification benefits along with opportunity for alpha.
The requirement to continue to look more broadly for diversifiers
As stock and bond correlations turned positive this year, limiting the investment universe to traditional asset classes isn't an option anymore.
Indeed, some segments of alternatives will require more selectivity to reveal benefits, but the more defensive segments and true-uncorrelated asset classes such as natural capital or hedge funds can bring value to most asset allocations.
