For now, markets remain caught between two opposing forces. On one side of the debate, the loss of economic momentum in both developed and emerging countries is evident. Hopes that a strong recovery in China would support global growth have collided with the reality of a more modest reopening in the absence of significant economic policy stimulus. At the same time, tensions around the US debt ceiling and the repercussions of instability in the financial sector have made financial conditions more restrictive.
On the other side of the debate, it is increasingly clear that inflation is declining globally. This is partly thanks to the fall in the prices of raw materials. Furthermore, services prices are also starting to return to levels more consistent with central banks’ targets. The tightening of monetary policy also appears to be nearing completion in many parts of the world and this is supportive for markets.
At the same time, the earnings season has been better than expected, especially for technology companies. The brighter prospects for corporate profitability in 2023 are another favorable factor for the markets.
The implications for the asset allocation of a diversified portfolio are that, in our view, a moderate overweight in both equities and bonds remains appropriate. However, some adjustments in the allocation within asset classes are advisable. Within equities, uncertainty around the Chinese recovery and its spillover into Europe argue for a trimming of the overweight in Asian equities, a reduction to neutral of the exposure to European markets and a neutral position on emerging Europe and the Middle East. In contrast, attractive valuations and solid performance of Japan equities warrant an overweight position.
Among fixed income assets, increased bond yields and the nearing of the end of monetary policy tightening make longer-dated government bonds attractive, including local currency emerging market debt. Finally, to limit the riskiness of the portfolio, exposure to high yield bonds should be reduced in favour of investment grade corporate bonds.
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