Sentiment Will Be Guarded, And Investors Are Likely To Favor Companies With Strong Balance Sheets
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Fixed income: Selecting how bumpy the road
Following a year in which the entire yield curve has shifted upwards, lower prices for bonds across the quality and duration spectrum are creating opportunities in fixed income.
For example, the HY segment is providing near 10% yields with shorter durations, while IG debt is yielding over 5% with longer durations. Going into a recession, the default rate tends to increase, which can cause some price volatility for HY as a category. However, taking a longer-term view and relying on quality credit research can provide opportunities. The question for an investor is whether the relative safety of the higher credit quality inherent in IG is being priced appropriately relative to the lower-quality HY—and providing a smoother ride. While history suggests that default rates will rise as the economy slows, the reality is that last year’s price declines create opportunity for security selection and sub-asset class rotation. This is in marked contrast to most of 2022, when the directional move in bond yields (beta) swamped active returns (alpha). In the fixed income section, you will find insights into opportunities from our investment teams, which generally reinforce our views about being selective and tilting back toward bonds for income.
Equities: Value, emerging markets or themes?
What equity factors are likely to fare best in 2023? Will it be growth, quality, or value? Or perhaps emerging markets? The first half of 2023 is apt to be a challenging one for corporate profits and risk premiums. Many sectors that screen as value, such as financials or industrials, are traditionally cyclical and are likely to be hit by earnings downgrades. The most successful companies of this century are those that invest relatively little in physical capital but enjoy high returns on intangible assets such as brand, technology, economies of scale or first-mover advantage.4 Cyclical firms are more exposed to a sales slowdown, which is likely to be the case in the coming few quarters.
Finally, and perhaps most importantly, as markets digest the implications of the Russia-Ukraine war on inflation in early 2023, uncertainty is likely to remain elevated. Sentiment will be guarded, and investors are likely to favor companies with strong balance sheets and sound business models, at least until a genuine global economic recovery takes shape. Value and emerging markets may do better later rather than earlier in 2023. Here, too, investors are likely to benefit from active security selection. In the equities section, we highlight the theme of semiconductor chips and provide a small window into how just one theme can provide a multitude of opportunities to consider
