One cycle ends… Although the global economy continues to slow, several factors have contributed to a somewhat more optimistic outlook for the global economy at the start of 2023. They include a sustained fall in US inflation, signs that inflation is beginning to decelerate in Europe too, the faster-than-expected reopening of China’s economy and a warmer-than-normal European winter. Some of the leading indicators, from the German Ifo to the purchasing managers’ indices for many countries, have improved from low levels and job markets, generally, remain quite resilient. But even though it’s now somewhat clearer that the outlook appears less gloomy than previously thought, risks remain and the global economy isn’t out of the woods yet.
…another begins: Central banks hiked interest rates aggressively to slow activity and bring down inflation, and their policies seem to be working. Following a recessionary impulse at the start of the year, we expect a new economic cycle to take hold some time in the second quarter. Global growth should recover moderately, driven by peaking interest rates, slower inflation, fewer supply-chain strains and China’s post-Covid stimulus, reopening and subsequent rebound. However, US-China tensions, the war in Ukraine and any impact on energy prices are still key risks and inflation may well remain stickier than expected. This could further squeeze incomes and lead to more hawkish central banks once again, especially in the euro area.
Here’s why this matters:
Bonds are back: With interest rates high (relative to the past decade) and likely to peak this year, we believe 2023 is the year that bonds are likely to make a comeback. We’ve recently taken advantage of the bond valuation reset and shifted our fixed-income allocations away from higher-risk/lower-quality emerging market (EM) bonds – both local and corporate – and towards safer developed market bonds such as US Treasuries and EU/UK investment grade debt. After years of low expected returns from safe bonds, we now expect them to provide a more meaningful long-term return to portfolios. This allocation allows us to achieve an attractive yield without the need to take on more credit risk, which is something that has been difficult in the negative-yielding world prior to 2022. Spreads on EM hard currency sovereign bonds have tightened considerably, though for now we’re maintaining our position.
Selective on equities: We remain slightly underweight but believe a well-diversified equity mix can benefit from any renewed spurt of economic growth. We could increase our exposure if inflation and interest rates fall more rapidly than expected, the Ukraine War ends, China reopens even faster or corporate earnings improve substantially. However, recent news suggests this isn’t currently the case. We still favour EM equities, which should benefit from China reopening (especially the Asia-Pacific region). Our single-line equity portfolios are tilted towards quality-growth stocks, which are recovering strongly after a tough 2022 and are mostly present in the US – where we’ve tactically allocated slightly more than normal together with high-dividend and low-volatility stocks for extra diversification. Despite the rally, we’re cautious on European equities as we think the market already discounts a good amount of positive news.
Meanwhile, we’re watching several key data releases next week…
Cycle watching: The US ISM survey for the manufacturing sector (Wednesday) should remain below the 50-threshold separating expansions from recessions. However, the equivalent number for the services sector (Friday), which has recently picked up in Europe, is likely to remain resilient and continue to point to growth. Wednesday and Friday will also see China’s manufacturing and services purchasing managers’ indices, which the market is likely to watch closely for any possible improvement. Lower energy prices and healing supply chains – along with more subdued demand – should continue to contribute to inflation moderation, though from high levels: investors will want to see that consumer price inflation for Germany (Wednesday) and the euro area (Thursday) slowed further in February, though this effect is likely to be more pronounced in March/April.
Daniele Antonucci | Chief Economist & Macro Strategist
This document has been prepared by Quintet Private Bank (Europe) S.A. The statements and views expressed in this document – based upon information from sources believed to be reliable – are those of Quintet Private Bank (Europe) S.A. and are subject to change. This document is of a general nature and does not constitute legal, accounting, tax or investment advice. All investors should keep in mind that past performance is no indication of future performance, and that the value of investments may go up or down. Changes in exchange rates may also cause the value of underlying investments to go up or down.
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