In 2022, the majority of things that could have gone wrong for investors did go wrong.
Markets that entered the year with extended valuations buckled in the face of elevated inflation, an aggressive global rate increase cycle, the conflict in Ukraine and China’s economic challenges.
Unusually, stocks and bonds experienced significant losses in 2022, making it one of the worst years yet for a balanced portfolio.
The consequences of global tightening
In 2022, central banks around the world initiated an aggressive global rate increase cycle to combat elevated inflation.
Although there are indications that global inflation is on track to decline, it is unclear by how much and how quickly.
While investors may, at first glance, welcome this news, historical evidence suggests that the real economy suffers the greatest damage after interest rates have already risen.
The bad news: We believe a recession is likely in 2023.
The good news: Central banks are likely to soften the rate increases and inflation will most likely fall.
Valuation resets: the best in a decade
In our opinion, a dramatic reset in valuations, with higher yields and lower stock multiples, has created the most attractive entry point for a traditional portfolio of stocks and bonds in more than a decade.
In fact, our long-term outlook for returns across asset classes is significantly more optimistic than it was a year ago.
For 2023, we think investors can focus on two central questions.
Question: What assets might help protect my portfolio through a recession?
Answer: Core bonds
Q: How much future damage to cash flows and corporate earnings do risk assets already reflect?
A: Substantial risk — but probably not all
We believe that investors can now find opportunities in core bonds, preferred equities, small and mid-cap stocks and infrastructure and transport assets.
Through 2023, as markets shift to reflect the anticipated economic limitations, additional opportunities will probably emerge in sectors such as real estate and large-cap equities.
Bonds are back
Only a few quarters ago, traditional fixed income faced a significant challenge: it offered neither an enticing level of income nor sufficient protection against economic downturns.
With Treasury, corporate and municipal bond yields at their highest levels in a decade, income and portfolio diversification are once more available.
That’s a change that all investors should pay attention to.
In many segments of the fixed-income market, current yields are now equivalent to historical equity returns.
This could provide an opportunity for investors to achieve their objectives with less risk.
As interest rates decline during a recession, longer-duration core fixed income (such as investment-grade corporates or municipal bonds) may offer potential total returns in the double digits.
Stocks: reversal of fortunes
In 2023, we anticipate that equities are well positioned to deliver positive returns, and any material decline from current levels could represent a good buying opportunity.
In terms of specific sectors, health care continues to be our preference because revenues aren’t as cyclical as they are in other sectors and valuations seem reasonable.
However, we also see opportunity in quality, cash flow–generating tech and tech-related companies that were hit by higher interest rates.
Industrial companies, on the other hand, provide some inflation protection and benefit from the tailwind of global infrastructure and defence investment.
Dividend growth and value companies could be well positioned, given the uncertain macro environment and higher interest rates.
A banner year for alternatives
Private markets that were once thriving have begun to experience the strain that is virtually inevitable in public markets.
The assets of growth equity funds, real estate vehicles and private credit managers have all been marked down to varying degrees, and further markdowns are likely.
In contrast, other alternative investments, such as hedge funds that concentrate on rates, currencies and cross-asset correlations, had a banner year and demonstrated their value as portfolio diversifiers.
Gold may serve a similar function in 2023 as the dollar and real interest rates reach their apexes.
In 2023 and beyond, we anticipate a renewed emphasis on stability and security throughout the global economy.
Real assets such as infrastructure, transportation and the energy transition create a wide range of possibilities for public and private investors.
Overall, 2022 tested the resolve of many investors. The equity markets experienced one of their most severe declines in history.
Not only were bonds incapable of shielding portfolios from the equity sell-off, but they also suffered their steepest losses in decades.
However, better days are ahead. Even as the economy worsens in 2023, we believe markets could stabilise.
The global reset in valuations is presenting investors with a broader range of viable options to help achieve their goals.
Most importantly, we encourage investors to focus on their process.
To first define and revisit their financial goals and then design the investment portfolios with the potential to reach them.
Steven Rees is head of investments for the Middle East and North Africa at JP Morgan Private Bank