To state the obvious, it’s been an extremely difficult year for investors as markets digest higher inflation, rising interest rates, and geopolitical uncertainty. Both stocks and bonds have experienced broad declines while asset categories that benefit from higher inflation, such as commodities, have generated gains. As of the close on Friday, September 16, 2022, the broad global equity market (MSCI All Country World Index) has declined by almost -20% so far in 2022 while the technology-heavy NASDAQ 100 Index is down over -26%. Traditional “safe” assets, like investment grade fixed, income have also experienced declines as bond yields increased sharply over the past several months alongside monetary policy tightening. For example, the Barclays 1-10 Year Municipal Bond Index has declined -6% on a year-to-date basis in 2022.
The economic outlook has deteriorated, and we assume a continued deceleration in US and global growth driven by tightening monetary policy in response to sustained high inflation. The near-term (next 12 months) recession risk continues to rise and represents a reasonable conservative scenario, but is not a certainty. Most relevant to investment strategy is assessing the potential severity of any economic downturn and its impact on corporate earnings and interest rates—and what is being discounted in asset prices. Given the strength in corporate and consumer balance sheets, we believe any potential recession is likely to be brief and shallow—perhaps a more “normal” type of cyclical recession rather than akin to the 2008-2009 financial crisis or the 2000-2002 dotcom bubble burst. And the sharp fall in stock prices already experienced this year suggests markets have priced in some expectation of meaningful earnings decline.
The economic and geopolitical backdrop remain highly uncertain; therefore, market volatility is likely to remain elevated. While risks have risen, starting point valuations have also improved—indicating better prospects for future long-term returns. In the current environment, we believe that proper diversification beyond traditional US stocks and bonds remains as important as ever. Our tactical portfolio positioning themes include:
- Continue to target an underweight position to core/investment grade fixed income, but add to municipal bonds given recent weakness and more compelling yields. High yield credit remains attractive given recent spread widening.
- Maintain an underweight to US stocks while emphasizing higher quality companies. Despite more attractive valuations following recent declines, we remain somewhat concerned that earnings expectations may still be too high.
- Remain fully invested in non-US stocks that trade at a steep discount in valuation relative to the US, as a lot of bad news and negative sentiment is already priced into these markets.
- Continue to target an overweight position to public “real assets” like commodities and energy-related stocks given the risk of sustained higher inflation.
- Where appropriate, continue to develop private equity and real estate investment programs to potentially enhance long-term returns.
Please see the attached presentation that provides our assessment of the market backdrop and shares our views on portfolio strategy going forward.