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Portfolio construction themes
The investment environment remains cloudy. While aggressive rate hikes may finally be behind us, we don’t expect rate cuts before the end of 2023, meaning investors must still contend with the “higher-for-longer” rate environment. And recession odds have increased, although we don’t anticipate a long or deep contraction. This backdrop is causing many investors to avoid taking action. Continuing to wait it out, however, is likely a mistake, as it carries its own risks. Our portfolio construction themes suggest a number of investment ideas that look better than simply holding cash.
Asset class “heat map”
Our cross-asset class views indicate where we see the best relative opportunities within global financial markets. These are not intended to represent a specific portfolio, but rather to answer the question: “What are our highest-conviction views when it comes to putting new money to work?” These views assume a U.S. dollar-based investor seeking long-term growth and represent a one-year time horizon.
- Dip a toe in first to get out of cash: This is the primary investment theme coming out of our recent GIC meeting. We know many of our clients are sitting on large cash allocations, either because they are awaiting enhanced clarity about the economy or because they believe that receiving nearly 5% returns from cash is a viable low-risk option. But with inflation starting to moderate and growth likely to slow, cash yields are unlikely to stay that high, creating reinvestment risk. The bottom line is we see more compelling opportunities in select areas of the global financial markets.
For those looking to increase yield without moving into full risk-on mode, we think it makes sense to explore areas of the broad bond market, including municipals. Figure 1 shows the returns of various asset classes during different rate and inflation environments. And while the past doesn’t guarantee the future, history suggests that core fixed income and municipals are solid “cash off the sidelines” candidates (1) in periods following rate hikes (when their effects are working through the economy) and (2) when rates are being cut amid economic weakness. A number of other areas also offer favorable risk/ reward tradeoffs, as detailed below and in our “best ideas” section of this outlook.
- Explore international waters: A second clear theme that emerged from our GIC discussions is that investment ideas from outside the U.S. are worth exploring.
In equities, we suggest balancing the benefits of U.S. large caps (which we think will perform well given moderating inflation, stabilizing yields and tailwinds from the tech sector) with those in emerging market equities (where we see tailwinds from attractive valuations, the weaker dollar and looser monetary policy in China). We’d also point to Europe’s banking sector, which is stronger than its U.S. counterpart, as a potential source of promising opportunities in European stocks and bonds alike. Additionally, we see attractive investments in non-U.S. alternatives, including real estate and real assets.
- Find an oasis in real estate beyond the office: The recent banking sector crisis (and continuing associated uncertainty) has many investors wondering if the real estate office sector will be the next figurative shoe to drop, and how office property dynamics could impact their portfolios. We expect challenges in this sector to persist, but we don’t foresee broad financial contagion as a result. Office vacancy rates, while high, tend to be concentrated geographically, and U.S. regional banks that are already under pressure generally don’t have exposure to large office buildings or complexes. Outside of the office sector, real estate fundamentals look strong.
Looking past office-related headlines uncovers some interesting possibilities for real estate. We are largely focused on non-office public and private real estate sectors, including retail, housing, industrial and alternative areas. Public REITs are especially worthy of consideration based on favorable valuations and relative earnings, along with dividend stability and solid balance sheets.
A close look at credit
Public markets fixed income should fare well once it becomes evident that a recession is getting under way and that rates are going to fall.
We think private credit stands to benefit amid prospects for only a mild recession. In fact, current private credit vintages could be especially attractive, as today’s financial conditions make them more defensively constructed.
Lastly, a word on preferred securities, which we’ve downgraded a notch in our heat map. While preferred valuations have improved given the selloff related to bank failures, the banking sector and the asset class as a whole remain challenged. Importantly, though, we see select opportunities in non-U.S. bank and other issuers, including insurance, utilities, midstream energy companies and some super-regional U.S. banks.
We see a wide range of investment ideas that appear more compelling than cash.
Our highest-conviction views:
Infrastructure (+) has long been a favored area for us. Still-high inflation helps the asset class on a relative basis, and infrastructure tends to be resilient in the face of slowing economic growth. We have a modest preference for publicly listed over private infrastructure, which still might experience price lag effects as privates catch up to what public markets experienced last year.
Private credit (+) faces some slowing in new deal issuance, but fundamentals remain sound. These investments tend to focus on more resilient areas of the market such as health care, software and insurance brokers — all of which are relatively well-positioned to withstand economic downturns.
Municipals (+) remain a favored area where we think it pays to take on credit risk. Fundamentals are strong, demand has returned to the market and valuations look reasonable.
All market and economic data from Bloomberg, FactSet and Morningstar.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
A word on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria exclude securities of certain issuers for non-financial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
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This information does not constitute investment research as defined under MiFID.