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Bracing for a market paradigm shift

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By Jessica Penny
  •  
4 minute read

Investors are now confronted with a vastly different market landscape to a decade ago, an investment manager says.

While the Global Financial Crisis propelled markets for over a decade, investors will now need to make way for a “new normal” characterised by higher inflation, high interest rates, and impending recession risk, according to American Century Investments.

Victor Zhang, American Century’s chief investment officer, said the consequences of slower economic growth and capital allocation mistakes may be more severe.

“Investors should ask what adjustments they must make to their portfolios if such conditions hold for the long term, as is likely,” Mr Zhang warned.

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“First, investors must come to grips with the idea that the risk-taking that worked so well for many of us after the GFC may not be as successful in this environment. Second, they must embrace broader portfolio diversification to deal with greater uncertainty.”

He added that a recession is still on the cards for 2024, despite the Fed’s dovish pivot.

“Though many observers are now calling for an economic soft landing, we think high interest rates and tight credit conditions will continue to wear down consumers and businesses, slowing economic growth and weakening the job market,” he continued.

Mr Zhang foresees the US economy continuing to slow over the next 12 months. As such, he recommended investors may need to fortify their portfolios with more safeguards given higher-risk assets could experience greater volatility.

John Lovito and Charles Tan, American Century co-chief investment officers for global fixed income, agreed that the US economy, despite its surprising resilience, will not be exempt from feeling the full weight of higher interest rates, elevated inflation, and tighter lending standards.

“Currently, a modest recession seems the most likely outcome. Against that backdrop, US Treasury yields should move lower and credit spreads should likely widen,” Mr Lovito and Mr Tan noted.

The duo also expect inflation to moderate but conceded that reaching the Fed’s 2 per cent target rate may not be on the immediate horizon.

Will the ECB lead the easing charge?

American Century believes the next move by the Fed is likely to be a rate cut but noted that the European Central Bank (ECB) may be the first to ease.

“Following its fastest tightening pace in history, the ECB remains on hold and adopted a ‘wait and see’ approach amid heightened recession worries. Policymakers said they would hold interest rates at their multiyear highs until inflation cools to the 2 per cent target,” the firm noted in its Q1 outlook.

But with recession looming, American Century has expressed doubt over the ECB’s commitment to hold, particularly as inflation rates are notably higher in the UK, where elevated prices and a slowing economy complicate the Bank of England’s strategy.

“Furthermore, rising wages have pressured the inflation rate, fuelling expectations for an extended central bank pause or even potentially more tightening, even as growth stalls.”

The investment manager’s base case is that US inflation is expected to ease overall in 2024, but volatility in monthly inflation readings may still be triggered by base effects, geopolitical unrest, and fluctuating energy prices.

Moreover, American Century remained sceptical that the Fed’s cautious approach will engineer a soft landing.

“Historically, soft landings have been rare. As the economy – particularly the consumer component – continues to absorb the full effects of the Fed’s aggressive rate-hike campaign, we expect a recession to unfold,” the firm concluded.

Bracing for a market paradigm shift

Investors are now confronted with a vastly different market landscape to a decade ago, an investment manager says.

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