Banca March bets on fixed income as key asset in 2023 investment strategy
07 February 2023 Category: General
The Banca March Market Strategy Team forecasts that global economic growth will register a steep downturn in 2023 as a result of tighter financial conditions and the impact of inflation on purchasing power.
- There will be a significant pause in interest rate hikes in 2023 In the US, the Fed will deliver the final hike of this cycle between March and May, taking the terminal rate to 5%. In Europe, this pause will come after the summer, at 3.25-3.5%.
- Inflation will continue to taper off, but will not hit central bank targets. The impact of higher energy costs has already filtered through to services, so core rates will remain high.
- Fixed income will be the top performer this year, offering compelling opportunities for the first time in a decade: yields are now compensating the risk taken, especially in high-rated credit. Banca March continues to like short-dated, high-rated assets due to the inverted yield curve.
- The economic slowdown ahead will trigger episodes of volatility for equity markets over the year. The best opportunities will be in US and EM equities. As for the sectors set to outperform, the bank likes the financial sector - which offers greater exposure to higher interest rates and compelling valuations - and the tech sector - thanks to its profit generation capacity - among the cyclical sectors. There will also be opportunities in health and sectors with links to the energy transition.
The Banca March Market Strategy Team forecasts that global economic growth will register a steep downturn in 2023 as a result of tighter financial conditions and the impact of inflation on purchasing power. The real estate sector will feel the effects of monetary tightening, with global property prices now beginning to fall. In the US, for example, property sales are falling faster than in any previous interest rate hike process.
Despite this downturn, the positive performance of the labour market and the buffer afforded by surplus household savings accumulated during the pandemic will act as tailwinds for economic activity and should avoid a deep recession in most developed regions.
Among the advanced economies, the eurozone will post the weakest growth due to its high dependence on energy imports which, in the best-case scenario, will cause GDP to plateau in 2023. The Spanish economy will also register a steep downturn, but GDP will close 2023 with growth of +1%. Spain continues to lag behind in the economic recovery and will not recover pre-Covid GDP levels until year-end. This year's relative outperformance is therefore attributable to a weaker starting point, and particularly to the recovery of the domestic tourism sector, which will be a strong growth driver: in 2023, international tourist spending is set to grow by 6.8%, outperforming 2019 figures again this year.
As for potential positive surprises, the Banca March Market Strategy team highlighted that the recent reopening of the Chinese economy will buoy global growth and contribute in particular to reactivating Asian emerging economies.
Weak economic growth replaces inflation as primary concern
As for inflation, now that it has officially peaked, all the evidence suggests we are heading into a new phase: stabilising raw material prices and unimpeded supply chains by year-end will allow inflation to continue to taper throughout 2023. In addition, as the one year anniversary of the invasion of Ukraine approaches, the base effect of cheaper raw materials will help ease inflationary pressures. This downward trend in inflation means we will be approaching the end of central banks' rate hike processes.
2023: Fixed income is back
For the first time in a decade, fixed income is a compelling option and represents a real investment alternative to other assets. The reason for this is that when interest rates stop rising, fixed income tends to perform well, whether there is a recession in the following 12 months or not.
Against the current backdrop of an economic slowdown, Banca March likes high-rated corporate bonds, which offer lower default risk and are yielding over 4% globally. In terms of duration, we do not recommend taking positions at the long end, as rate curves remain steeply inverted and core inflation rates will take several months to normalise. Private debt also remains compelling, with acceptable risk levels: “The additional yield stems from the lower liquidity offered by the asset, not a higher risk of default, which historically has been no higher than in markets like high yield.”
As for equities, pauses in Fed rate hike processes are not necessarily a good thing, as the performance of the economy has a far greater impact; the key factor is whether or not the pause is accompanied by a recession. Earnings growth which is yet to price in the downturn in activity coupled with existing tight valuations offer more limited upside potential from current levels.
We prefer US equities thanks to the higher ROE offered by US companies and the country's lower energy dependence. We also see opportunities in EM equities, where downgrades to earnings forecasts have been far more aggressive. We believe the situation will shift now that the Chinese economy has opened up. In emerging markets, we particularly like Asia and expect to see opportunities generated by Chinese consumers enjoying their renewed freedom of movement.
In terms of sectors, Banca March recommends a combination of sectors offering the capacity to generate profits in the current macroeconomic landscape and others offering exposure to the economic transformation. We particularly like the healthcare sector thanks to its defensive profile and the resilience of earnings in the sector at times of economic decline. However, these positions can be combined with exposure to other cyclical sectors like the technology sector, which can generate profits that outperform the megacaps. It is also worth holding positions in sectors offering exposure to high interest rates, such as the financial sector, which currently offers compelling valuations. Finally, there are significant long-term opportunities in sectors linked to the energy transition and energy self-sufficiency.
Fixed-income will take centre stage in 2023 amid ongoing volatility for equity markets. The Banca March Market Strategy team's approach this year will be to ramp up risk whilst remaining fully aware that everything comes at a price, and that for the time being the smartest choice is to remain cautious on equities and harness the positive impact of higher base rates on fixed income.