Portfolio construction themes
Investors seeking to put this bear market behind them aren’t out of the woods yet. Hopes that inflation might peak quickly, that the U.S. Federal Reserve would pivot, and that the global economy could emerge unscathed — all have diminished. We are cognizant of the risks ahead: softer earnings, weaker employment picture and demand destruction that undermines the ability for the consumer to continue to be the hero. We suggest portfolio positioning that is designed to keep pace with inflation, cope with hawkish monetary policy and cautiously take advantage of longer-term trends.
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 investing for long-term growth and represent a one-year time horizon.
- Combating global inflation is more than a short-term play: Watching inflation data these days is like waiting for a fever to break: Until prices peak, there’s little hope for relief. With that in mind, we remain focused on asset classes that typically perform better in an inflationary environment — namely, farmland, real estate and infrastructure. Returns on these real assets have historically exhibited a positive correlation to inflation while offering portfolio diversification and relatively low volatility.
- Economic detox and bear market dynamics: We continue to witness an overheated U.S. economy detox from its pandemic-driven, stimulus-fueled state. There’s little doubt market volatility will persist as these economic factors play out. In 2022 alone, there have been four bear market rallies, each one stronger and longer than the one before it.
The question is: when does the bear break through and become a bull? Our U.S. Bear Market Tracker (Figure 1) captures the key data we follow to signal when the market may be nearing its bottom. In short: we’re not close, so we’re staying defensive. While some pain has already been reflected in valuations and bond spreads, we expect to see more rockiness ahead as corporate earnings deteriorate.
- Avoid the traps: We are still seeking mispriced asset classes (e.g., U.S. high yield) that may weather a recession better than conventional wisdom suggests. But we are also wary of equity markets outside of the U.S. that currently appear to fall into the category of “value trap.” European and Chinese equity valuations, for example, may suggest attractive opportunities on the surface, but serious risks remain, and we see an absence of positive catalysts that would warrant new or increased allocations. We prefer a generally defensive posture, favoring credit and real assets over equities. When our outlook improves, we would be inclined to suggest accelerating rebalancing to strategic weights.
Our highest-conviction views:
- U.S. high yield (+) may be an out-of-consensus idea, and spreads could widen from current levels. But we believe equities are more vulnerable. Shifting from equity into credit could allow investors to access “growth risk,” with relatively less downside potential, while also benefiting from attractive yields (~8%).
Entry points look attractive as well. Relative to U.S. equities, U.S. high yield is currently priced at one of its more attractive levels in recent history. Investors can receive a healthy yield at wider spread levels during the period leading up to tighter spreads. This is our “paid to wait” mantra.
- Non-U.S. developed market equities (-),particularly in Europe and the U.K., are facing stagflation risks exacerbated by the Ukraine-Russia war and an unprecedented energy crisis as winter approaches.
- We continue to de-emphasize emerging markets equities and debt (-). China is increasingly isolated as it pursues zero-COVID measures at any cost. Moreover, with a likely third term for Xi Jinping, we don’t expect an economic reopening until 2023. The strong U.S. dollar will continue to be a headwind in emerging markets.
Overweighting high yield is an out-of-consensus view, but relative risks, valuations and fundamentals create a strong argument for doing so.
And where we have disagreement:
- The extent to which private assets will reflect the pain felt in public assets. Those GIC members inclined to allocate to private assets highlighted their attractive return potential and the ability, due to structuring and less frequent pricing, to shield portfolios from market volatility — a major concern to investors right now.
On the other side of the issue, some GIC members highlighted how portfolios may have veered from their strategic weights to private assets due to public market pullbacks; the possibility of future mark-to-market pain; and that taking on more illiquidity could handcuff dynamism and the ability to take advantage of public market opportunities.
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. Past performance is no guarantee of 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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