Global Asset Tracker: Plotting a course through global uncertainty

Respondents to PWM’s eighth annual asset allocation survey recommend clients take a defensive stance in portfolios to counter multiple headwinds

After an annus horribilis for virtually all asset classes save energy, private banks entered 2023 in a defensive mode in client portfolios, expecting a deterioration of the global economy, as a lagged effect of the fastest interest rate rises in modern history, aimed at taming high, persistent inflation. This has been largely the result of the massive and unprecedented surge in money supply aimed at supporting the global economy in response to the pandemic.

Moreover, the sudden reopening of most economies early last year, with China’s continued zero-Covid policy exacerbating supply chain issues, caused a demand shock. This compounded the big increase in energy, food and industrial metals price rises, an effect of Russia’s war against Ukraine.

Central banks, led by the Fed, are using interest rates hikes as a “strong medicine” and “very blunt” instrument to slow aggregate demand across the whole economy, explains David Bailin, CIO at Citi Global Wealth.

“The Fed’s movement is so big, and its intention on crushing inflation is so large, that it will succeed. And because of that success, we are going to see earnings coming down, a slowdown in the economy and higher unemployment,” he says.

Citi is predicting the slowest economic growth in four decades, with the US, UK and Europe expected to grow by just 1 per cent in 2023. But once inflation is brought under control, most likely in 2024, the scenario will improve.

“Once we digest higher rates and lower profitability, which is driving market volatility, we can have a meaningful, very robust recovery in equities for the next several years after that,” says Mr Bailin, explaining that unlike the “entrenched” inflation of the “Volcker days” in the 1970s, the current situation is a result of external inflationary pressures.

Last year, markets may have experienced “the worst combined stock and bond performance since 1931”, but Mr Bailin advises against trying to time the market, which is “the number one destroyer of wealth”.

He recommends clients remain fully invested but overweight “defensive equities with good growth characteristics in recessions”, found in sectors such as biotech and life sciences, ‘old’ and green energy, defensive industrials, as well as dividend paying stocks, while cyclicals such as transportation and machinery should be avoided.

“The number one big mistake clients make is managing their cash poorly,” he says.

With bonds “nearing peak rates’’, clients must “capture that high interest coupon” and own more fixed income, as “high rates will be gone by next year”. He also urges US clients, typically too home-biased, to gain a more global exposure, highlighting the appeal of local Chinese equities and China-exposed global shares.

China and Europe are going to perform better than the US, predicts Mr Bailin, expecting the greenback to lose 5 to 10 per cent of its value over the next 12 to 18 months.

These views resonate, at varying degrees, with private banks’ chief investment officers who took part in PWM’s eighth annual Global Asset allocation Tracker (GAT) study. The research, conducted in January, surveyed investment and asset allocation intentions of CIOs, market strategists and heads of asset allocation at 51 institutions, managing a combined $18tn in client assets.

Most (92 per cent) expect central banks to complete their hiking cycles in the first or second quarter of 2023 at the latest. But inflation is forecast to remain above central bank targets in most major developed economies, and interest rates higher for longer than currently priced by markets. Volatile conditions favour active management, expected to outperform passive management by 70 per cent of respondents.

While an inflection point or pivot will likely lead to a shift from a defensive to a more aggressive stance for more than two-thirds, there is a strong consensus (94 per cent) that the global economy is not heading toward a deep and long recession (see charts below).

In an environment where central banks’ overtightening is believed to be the most likely downside risk, with only a third believing markets have fully priced in slowing economic growth and earnings, managing client money is complicated further by bear market rallies.

“There are a lot of gyrations in market signals and in macro-economic data, but ultimately what wealth managers do is invest for the long term,” says Alicia Levine, head of equities and capital markets at BNY Mellon Wealth Management. “Trying to chase every move in the market to reallocate or change, ultimately, doesn’t wind up being very successful because you tend to miss the big picture,” she says.

The big picture, says Ms Levine, is that tail risks have reduced over the past few months, as a result of the end of China’s stringent ‘zero-Covid’ policy, with the country fully reopening its economy earlier than expected.

The reduction of oil and gas prices, thanks to a mild winter and the ability of European governments to reduce aggregate demand and diversify their energy supplies, has supported the European stockmarket and economic recovery, with markets now pricing out severe recession in the old continent.

“When markets are down 20 per cent year over year, and you think about long-term investing, it does create a nice entry point,” says Ms Levine. The bank started 2023 with a neutral allocation to equities, having shifted assets to take advantage of “stronger growth impulse” coming out of China. It recently added “a bit more risk to client portfolios” to gain more exposure to Europe and small caps.

With inflation expected to remain higher, which will lead the Fed to keep interest rates higher than seen post-crisis, bonds are a good investment opportunity, both for capital appreciation and yield, she adds.

That bonds are back as portfolio diversifiers and income generators finds the highest consensus (96 per cent). This is a big paradigm shift, as last year bonds failed to protect portfolios as equities sold off, in fact generally experiencing greater losses, because of rapid interest rate hikes.

The return of 60/40 portfolios

Today more than 50 per cent have an overweight exposure to fixed income, when in 2022 most (93 per cent) had an underweight allocation (see charts below).

“The emergence of positive real yields and likely return to a negative correlation between equities and fixed income markets have made bonds a more attractive investment in 2023 than it has been in years,” says Fahad Kamal, CIO at Kleinwort Hambros. The UK bank has cut its underweight to government bonds to take advantage of “attractive income and protective attributes” but remains relatively short duration, to remove some sensitivity to the ongoing volatility in yields.

Others also show enthusiasm for this asset class. “We believe investment grade corporate credit may become the best investment in 2023 from a risk-adjusted return standpoint,” says Alvaro Manteca, private banking strategist at BBVA, also stating preference for short duration.

“The 60/40 balanced portfolio is back in a very big way and is going to do very well in the current environment,” says Citi’s Mr Bailin, explaining the bank’s “big overweight” to bonds.

Quality assets are generally preferred by our survey respondents, who favour developed corporate and government investment grade bonds, led by US Treasuries, followed by emerging market debt (see chart below).

“In fixed income, high-quality, long duration, developed market investment grade bonds could act as safe haven hedges against the risks of recession,” says Bank of Singapore’s CIO Jean Chia, who also favours select emerging market sovereign bonds. With history showing that the market tends to bottom before the end of the recession, she expects equities and credit to go through a volatile bottoming process, before recovering to higher levels by the end of 2023.

Emerging market debt experienced “one of the greatest drawdowns ever” last year, explains Christel Rendu de Lin, CIO at Bank Vontobel. “But the picture for emerging market debt is much stronger for 2023, given the exceptional mix of high yields, appealing valuations and a global environment that is more favourable for both fixed income and emerging markets,” she says.

Another high conviction call for the Swiss bank, shared by many respondents, is gold. “Many of the headwinds which plagued gold in 2022, including a hawkish Federal Reserve, a strong US dollar and rising real yields, should turn into tailwinds in 2023,” adds Ms Rendu de Lin. “In addition, we also appreciate the yellow metal as a hedge against escalating geopolitical risks.”

Vontobel has a cautious overweight to equities, noting that from peak to trough in October 2022, global equities retracted by around 30 per cent. From a regional perspective, areas like Europe and China provide solid valuation support, while regions such as the US and Switzerland are more expensive but offer higher quality earnings, says Ms Rendu de Lin. “Given our assumption of a short and shallow recession we believe a modest overweight equities is reasonable.”

Fifty per cent of private banks, though, express their cautious stance through an underweight position to equity, while over the past two years most had an overweight allocation to stocks.

“Despite investor bearishness and low equity exposure, we do not believe developed market equities are out of the woods yet,” says Pictet Wealth Management’s head of investment and CIO César Pérez Ruiz, explaining the bank’s underweight position to stocks overall.

“While sales growth and cash returns to investors could be bright spots, corporate margins are coming under increasing pressure, likely leading to further earnings downgrades.”

Within the equity space, respondents find most attractive opportunities in high quality stocks with pricing power, as well as dividend paying equities, while value stocks are expected to outperform growth (see chart below).

Bright spot

Geographically, emerging markets and Asian stocks, led by China, are seen as a bright spot, with a weaker dollar expected to enhance the improving trend in developing countries. “Not only has Beijing abruptly ended its zero-Covid policies but the tone on the economy and on private companies – including tech leaders and, critically, real estate – has shifted 180 degrees,” says Yves Bonzon, CIO at Julius Baer group.

Chinese markets have staged an “impressive recovery” from last autumn’s depressed levels, he says, expecting China to significantly contribute to global demand from the second quarter. However, with policy reversals in China becoming the “new norm”, Mr Bonzon cautions against market timing. “Investors should be reminded that an economy now even more tightly steered by central interests commands a higher risk premium than in the past.”

Asia ex-Japan equities, as well as Asian US dollar-denominated credit, are a high conviction call for Standard Chartered Bank, which has an overweight exposure to these segments, while remaining underweight equities and overweight bonds.

“Asia ex-Japan continues to trade at a valuation discount to global equities. We expect limited valuation downside and the highest earnings per share growth among all major regions, aided by mainland China’s pro-growth policies,” says Manpreet Gill, Standard Chartered’s group CIO for Africa, the Middle East and Europe. “Despite the rebound we’ve seen, Chinese equity valuations are still very inexpensive.”

Emerging market and Chinese equities only represent a small proportion of client portfolios, around 7 per cent in this year’s private banks’ strategic allocation, on average.

The Chinese recovery, however, will positively impact other economies too, especially Europe, says Lars Kalbreier, global CIO Private Banking, Edmond de Rothschild, as the continent is China’ most important trading partner. Luxury and consumer-oriented businesses will greatly benefit from the reopening, he explains, as sales to China represent more than a quarter of big European luxury firms’ sales. Chinese travellers and tourists in Europe, absent from the continent over the past three years, account for 5 to 10 per cent of their sales.

China’s recovery, combined with falling energy prices and cheap valuations, make European equities attractive, which are also supported by growing US fund flows into Europe, says Mr Kalbreier.

More than 50 per cent of private bank CIOs have a positive outlook for European stocks,  while only a few believe US stocks will outperform international and emerging market stocks this year.

That does not make the US market less appealing, though. With communication services and information technology firms now representing about 40 per cent of the S&P 500, the US market had a difficult 2022, in a rising rate environment. But it remains a centre of innovation, as highlighted by recent developments in the AI space.

“As the Fed has embarked on quantitative tightening, the world has entered a new market cycle, with higher rates and higher inflation, where value-oriented stocks will outperform. But investors should have a broad allocation to growth and tech too, as this is where innovation comes from,” says BNY Mellon’s Ms Levine.