After the challenging investment environment of 2022, Principal Asset Management has suggested that the outlook for 2023 is more positive, at least for some parts of the market.
The firm has identified three key themes that it believes will drive financial markets over the next year, including the movements of the US Federal Reserve, China reopening from its COVID-19 lockdowns and the strength of the US dollar.
“Inflation and central bank policy will likely continue being key focus points for investors,” said Principal Asset Management chief global strategist Seema Shah.
“Yet, while persistently restrictive monetary policy and the likely resulting US recession will weigh on the broad equity market outlook, it implies opportunities for both core fixed income and real assets.”
According to Principal, the Fed is expected to raise interest rates a few more times in 2023 but is likely nearing the end of its current tightening cycle.
“This implies that bonds will be able to support portfolios as recession approaches, with government bond yields under downward pressure and securitized debt typically providing mitigation during periods of volatility and risk,” said Ms Shah.
“Within credit markets, the longer duration, high-quality profile of investment-grade should be capitalized. Importantly, credit now offers more attractive yields than in recent years, finally meriting portfolio allocation.”
In China, Ms Shah suggested that an easing of COVID-19 restrictions next year could offer some respite if the government provides policy stimulus alongside the reopening.
“The past two years have been a tough slog for China investors. In 2021, despite a modest economic recovery, intensified regulations and anti-monopoly measures led to a steep valuation contraction in Chinese assets,” she said.
“In 2022, although the regulatory environment had marginally improved, the government’s restrictive COVID-19 policy and a deep property market downturn ensured a continuation of the weak economic and market backdrop.”
Ms Shah stated that it has become increasingly evident to the Chinese government that the key to unlocking a recovery will be an unwinding of its ‘zero-COVID’ policy. But she noted that a full reopening shouldn’t be expected to take place overnight.
“A roadmap for an end to China’s stringent COVID-19 measures, coupled with additional stimulus policies, should provide the catalyst for a significant rebound in Chinese economic activity and risk assets in 2023,” Ms Shah predicted.
“The positive impact should extend far, providing a boost to its major trading partners across Europe and particularly Asia. Global commodity prices also stand to benefit.”
As for the US dollar, Ms Shah said that the currency has been a standout performer over the past year, particularly compared to traditional equity and fixed-income assets.
“Unfortunately, the U.S. dollar’s strength has intensified and deepened economic challenges around the world, lessening the attractiveness of global risk assets,” she said.
Looking ahead, a sustainably weaker US dollar is expected once the Fed delivers a few more rate increases as expected before pausing in the first half of next year, which will help to brighten the relative outlook for both emerging markets and European global risk assets.
“While 2023, with its challenges and risks, certainly looks daunting, a clear playbook is beginning to emerge,” said Ms Shah.
“Diversification across asset classes is both recommended and appealing; inflation mitigation continues to be necessary; and taking advantage of attractively valued global opportunities will likely be rewarded.”
