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4 Investment Portfolio Ideas to Position for a Possibly Turbulent 2023
Investors may continue to face turbulence in 2023 as high inflation and rising interest rates pivot to a potentially weak global economy. Lower corporate profits and revenues could hurt investment returns, but investor sentiment may improve to counteract those negative forces as inflation and central banks settle down. With this balance in mind, here are a few portfolio ideas, based on our 2023 market outlook.
#1: Favoring Developed-Market Stocks over Emerging Markets May Aid Portfolio Stability
Slowing economies in developed markets are likely to pressure corporate sales and profits downward, sufficient enough to fuel investor fears. But we think pockets of U.S. economic durability, demonstrated last year even in the presence of aggressive rate hikes, will limit a U.S. earnings slowdown. Further, investor sentiment, beat down in 2022 by volatility and losses, likely has runway to improve this year if central bank rates plateau and inflation continues to fall. Even in a sour economy, this potential pivot in sentiment could support stocks, particularly in Europe where they are cheap based on historic price-to-earnings comparisons.
With emerging market equities, China’s reopening from COVID-19 lockdowns incrementally improves the outlook. However, we think the recovery will hit bumps and snags as the country continues to struggle with an aging population, real estate losses, and other countries seeking supply-chain independence by pulling some of their manufacturing out of China.
#2: Consider Natural Resource Stocks to Possibly Enhance Returns from China’s Reopening
In 2022, natural resource stocks delivered some stability to the diversified portfolio. They showed they can benefit from higher inflation, especially when driven by surging commodity prices. Looking to 2023, we see more upside to commodity prices. China’s reopening likely will induce demand while supply stays restricted because of underinvestment in production of commodities and the war in Ukraine. Natural resource companies’ cash flows and balance sheets have improved significantly to better weather potential economic difficulties while maintaining attractive valuations. Besides acting as an inflation hedge, investors may use natural resources as a potentially lower risk way — compared to emerging market equities — to benefit if China reopens successfully.
#3: High Yield Bonds May Provide Reslience and Income
We think high yield bonds stand among the most attractive investments in 2023 because of yields of around 8%, unusually strong credit quality among high yield issuers, historically lower sensitivity to changes in interest rates versus other bonds, and corporate resiliency backed by solid fundamentals. We expect default rates to rise off of record lows but remain below the long-term average as strong cash flows support issuers’ ability to pay and upcoming debt maturities for companies look benign. Global investors continue to search for investments that provide income and serve as a hedge for interest rate volatility, which we believe will support high yield valuations through 2023.
#4: Seek Potentially More Promising Opportunities over Investment Grade Bonds
With the increase in yields, investment grade bonds look more favorable than past years. We believe Treasury yields will remain rangebound and investment grade credit spreads will remain near current levels, providing possible stability to investment grade.
However, we think interest rate volatility will remain high, and investment grade bonds historically have been much more sensitive to interest rate changes than high yield bonds. Even if interest rates fall, providing support for investment grade returns, we think equities and high yield bonds could benefit more depending on the nature of the decline. We believe investors can find good opportunities outside of investment grade bonds to enhance their portfolio risk/reward profile.
The Challenge of Positioning for a Delicate Balance in 2023
We think investors will need to position their portfolios for the immediacy of disappointing global growth against the backdrop of greater certainty on central bank policy, potential reduction in interest-rate volatility and the possible return to economic growth later in the year. That balancing act won’t be easy because we expect a recession in Europe, better-than-even odds of a recession in the U.S., and continued struggles in emerging markets. Even more, we think high inflation will persist longer than implied in financial markets. But if clear and decisive signs show that inflation has been tamed, the forward-looking nature of financial markets means sentiment and investment performance may turn positive quickly even if the global economy is struggling.
Download our 2023 market outlook research paper.
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