As rates remain high and growth slows, what should investors focus on?

Despite the reopening of China’s economy, a weaker US dollar and easing inflation expectations, equities in emerging markets have performed poorly so far this year

It is important for investors to act before markets start repricing. Getty

The macroeconomic outlook is bound to continue to dim in the second half of 2023, yet central banks are unlikely to change course anytime soon.

It may take until 2024 before we see any meaningful policy change. This will keep investors in limbo as the news flow from the economy and from companies will gradually deteriorate while rates remain rather stubbornly high.

For us, this suggests sticking to a conservative investment approach. Cash per se is only a transitory position in the current context, as rates might well be lower – possibly even a lot lower – 12 months from now. Why not wait until the rate cuts materialise?

The trouble with that approach is that many other assets such as fixed income instruments, equities and commodities will start pricing in those lower rates well ahead of the fact and cash investors may then be facing much higher prices in those areas by the summer of 2024.

Thus, we suggest a conservative investment stance but a fully invested one along the respective investment strategy.

With regards to fixed income investors, this means they should look at staying in quality and locking in decent real yields as long as they are still positive.

On the flipside, we suggest cutting exposure to high-yield bonds to underweight, both in the US and Europe, as default rates may jump in the second half of the year due to the stubbornly high rates and a deteriorating economic performance.

With regard to emerging market bonds, the picture is a lot brighter in relative terms and we allocate the full credit risk budget to this space.

Despite the reopening of China’s economy, a weaker US dollar and easing inflation expectations around the globe, equities in emerging markets have performed poorly so far this year.

The prospects for emerging market equities to outperform their developed market counterparts are caught between the supportive recovery of China’s economic cycle, which is different from that in the US and Europe, and the looming risks of a recession in the world's largest economy.

However, we believe that emerging market assets have room to catch up in the second half of 2023, as a weaker US dollar, policy easing and China’s continuing recovery provide significant tailwinds.

With investor sentiment tilting towards risk aversion, we remain cautious on emerging market equities and suggest maintaining a neutral stance versus developed markets.

For investors seeking exposure to the asset class, we find pockets of opportunity in Asia. We repeat our "overweight" rating on South-East Asian equities due to their defensive nature, supportive gross domestic product and earnings per share growth, and robust balance sheets.

Furthermore, we maintain an "overweight" rating on India, as favourable economic policy and the composition of the private sector support the county’s long-term structural growth.

Within currencies, we reject the notion that a process of de-dollarisation is taking place. Instead, we view the decline in the US dollar as a cyclical correction that has further room to go. The Swiss franc and Japanese yen will probably benefit for different reasons, while emerging high-yield currencies are bound to soar on their rate advantage.

In commodities, we do not share the notion of a structural commodity bull market in the making. While we do not see commodities starting a new super cycle, we expect copper to join the one currently under way in battery metals.

This segment-specific super cycle is driven by the energy transition, in general, and the shift to electric mobility, in particular. Electric vehicles need three to four times as much copper as their conventional peers.

Copper demand related to the energy transition is set to grow strongly over the next decades, offsetting structural headwinds from China’s demographics and slowing urbanisation.

Crucially, however, any structural shortage will come from the supply side, rather than the demand side, of the market. A lack of investment in new mines in the past few years is bound to lead to a significant slowdown in supply growth from the middle of the decade.

This should result in a structurally undersupplied copper market between 2025 and 2035, which should, in turn, put upward pressure on prices, bringing them back above $10,000 a tonne.

In terms of our next generation themes and subthemes, we highlight the attractiveness of shifting lifestyles, given the slowing macroeconomic momentum, and of cloud computing and artificial intelligence, as the AI race has only just begun.

In short, our overall view is that investment opportunities are plentiful even if the news flow, going forward, may remain challenging.

However, to benefit from these opportunities, it is important to act before markets start repricing.

Christian Gattiker is head of research at Julius Baer