Uncertainty Expected to Dominate Global Markets
Portfolio diversity with downside protection and active management are the best way to find investment success in 2023, a new report from WTW argues.
The firm’s Global Markets Overview on portfolio priorities for a “surprise-free 2023/24,” outlined how investors can find returns while controlling the impact of economic volatility.
The report noted that current asset market pricing implies there will be a drop in inflation in response to central bank interest-rate hikes, leading to cuts in those policy rates and only a moderate economic slowdown.
However, “We think this understates the potential for higher-than-expected inflation, higher-than-expected interest rates, and/or lower-than-expected growth,” the company formerly known as Willis Towers Watson wrote.
The analysis identified several data trends of which asset allocators should be aware and concluded that things will be uncertain for some time to come.
“The major economies remain imbalanced; the path back to balance is likely to be volatile; and portfolio responses need to adapt,” the report stated.
Regarding 10-year bonds, WTW is neutral, concluding that factors driving core inflation persist in the U.S., while Europe faces ongoing uncertainty due to the war in Ukraine. The firm is also neutral on corporate credit, noting that “the fall in investment grade spreads this year means global corporate credit markets are now pricing in a below average allowance for the level of credit losses over the medium-term, driven primarily by U.S. credit pricing.”
In the high-yield market, WTW expects losses to be “at or modestly above” the levels in IG credit in the near term, “with risks tilted towards higher losses.”
“High quality credit assets are at levels at which they are likely to provide moderate returns above equivalent maturity government bonds over the medium-term,” the WTW report stated. “We retain a somewhat more cautious outlook for developed market speculative-grade credit given shorter-term risks and recent falls in credit spreads. Current pricing implies a below average level of defaults relative to historic average pricing, in the US especially.”
Regarding securitized assets, the firm wrote that “market pricing appears to be pricing-in a similar outlook, in aggregate, relative to traditional corporate credit markets.”
Overall, WTW concluded that corporate earnings are showing some signs of weakness as global economies slow, but that the potential weakness is not incorporated into analyst expectations for 2023 earnings.
This led the firm to state that while the stock market drops in 2022 “were mostly caused by rising interest rates, rather than lower growth expectations. Therefore, equities are not pricing-in future earnings weakness and face near term downside risks if growth weakens further and/or earnings expectations get revised down.”
Due to that pattern, WTW pointed to opportunities in Japanese and U.K. equities because the firm sees valuations continuing to be low relative to broader DM equities.