Higher interest rates put pressure on valuations during 2022, but the focus will now shift from valuations to corporate earnings in an increasingly challenging macro environment.
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International Macro Scenario
Conservative projections, with risks of a “mild global recession” this year.
Projected global growth for 2023: 2.3%, projected growth for developed economies in 2023: 1.1%, and projected growth for emerging economies in 2023: 3.8%.
China's reopening may help offset weakness in developed markets, but it could also put pressure on inflation expectations.
2023 Base-Case Inflation Scenario: Inflation will continue throughout the year, but at a more moderate pace (around 4.0% for the U.S.).
Monetary policy: a slower pace but a higher peak (terminal rate around 5.0% and no rate cuts in 2023 in the case of the Fed).
Financial conditions have been easing, which is helping to keep inflation expectations firmly anchored.
Data from the real economy point to a growing likelihood of a recession, although this is limited in terms of key asset prices.
International Equities
The focus will shift from valuation to earnings in 2023
Much of the correction in the equity market during 2022 can still be attributed to a “valuation compression” resulting from higher interest rates driven by inflationary pressures, while corporate earnings expectations remained relatively resilient.
Looking ahead to 2023, the focus will shift from valuations to earnings. Everything remains a delicate balance between easing inflation and interest rate pressures and the deterioration of the earnings outlook.
Interest rates are limiting the rise in P/E ratios. Dividends and foreign exchange returns will be the most significant factors in explaining the performance of equity markets.
Tactically overweight non-U.S. markets. This trend is driven by the weak dollar and China’s reopening. Valuations are more attractive outside the U.S.
In terms of sectors and investment styles, we continue to overweight value stocks over growth stocks.
In the case of the U.S., our projections indicate that equities are trading at fair value (around 4,000 points for the S&P 500), which could, of course, be an overstatement, but this limits the potential for further recovery, given that valuations—both absolute and relative to bonds—are not particularly attractive.
Earnings are beginning to decline even further, given a more challenging macroeconomic environment heading into 2023.
Equities—particularly U.S. equities—do not reflect a recession.
International Fixed Income
As inflationary pressures begin to ease, an intermediate step in risk-taking should be taken through investment-grade fixed income.
The slowdown in U.S. inflation calls for a reduction in the pace of rate hikes, not in yield levels.
Overweight U.S. Investment-Grade (IG) bonds. Things are starting to look more attractive in the bond market. U.S. IG debt is currently yielding 5.0%, the highest level in 15 years. In a recessionary scenario, the decline in basis points more than offsets the potential rise in spreads, which is not the case for high-yield (HY) debt.
With regard to corporate spreads, the risk-return profile is not attractive, especially for high-yield debt.
U.S. fixed income carries a low risk of recession.
The Dollar and Commodities
A weaker dollar, stronger commodities
Interest rate differentials are becoming less favorable for the dollar given the expected sharper decline in U.S. rates.
Just as commodity markets were dominated by the dollar in 2022, they are expected to be driven by a lack of investment in 2023. From a fundamental perspective, the outlook for most commodities in 2023 is bullish.
Alternative Assets
Why Can Bad News Be Good for Alternative Assets?
Structurally higher inflation, where central banks will raise and/or maintain higher interest rates for longer, and where it seems as though the world revolves around one central bank: the Fed.
This will lead to greater volatility at the macro level, as a result of monetary policy responses that may come as a surprise. Differences in the aggressiveness of central banks will cause volatility in exchange rates and asset values.
As a result of this environment, fundamentals are more important than ever, asset selection has become more critical, and portfolios should focus on diversification and alpha rather than beta.
In this environment, unlike in the previous decade, capital will be scarcer, so there will be opportunities in private markets—both for financing and equity—and current investment rounds will likely yield returns above average.
Opportunity to diversify a 60/40 portfolio, reduce volatility, increase cash flow, or achieve decorrelation.
