The economy and markets
Key points to know
For global economic growth, it’s better to be lucky than good.
In our 2023 outlook, we cited weather as a source of global economic uncertainty. And the unusually warm winter in North America and Europe removed a significant amount of downside risk from the economic landscape. Consumers saved on energy costs, allowing them to spend more elsewhere, and headline inflation declined faster than expected. China, proving that idiosyncratic risk is not always negative, lifted its Covid restrictions, raising the potential that a strong rebound in household spending will lift Chinese output this year and contribute to additional global growth in the coming quarters.
Banking concerns vs. strong data
March’s U.S. bank failures have led investors to lower their outlook for policy rate increases over the balance of the year. But should this panic prove short-lived thanks to the swift and aggressive response from regulators, interest rates may rise again as economic data remains strong (Figure 2). Global consumers look resilient, as real income growth turns positive once more. Labor markets remain as tight as ever, and central banks continue to voice concern that this could lead to persistent inflation in service industries. Surprisingly strong growth brings with it the risk that inflation will fail to moderate without further policy tightening.
The “higher-for-longer” interest rate environment may already be here, which should spark ongoing volatility.
Just when you thought 2022 was over.
Investors don’t have to go back very far to recall a market environment driven primarily by fears of rising interest rates and high inflation. Few of us would like to repeat the 2022 experience. But until we see confirmation that growth and inflation are slowing, central banks will remain biased toward raising interest rates, making it difficult for either equity or fixed income markets to sustain the rallies that began back in November (let alone build on them). At the same time, we are not convinced the extremely strong economic opening to 2023 will hold in the coming months, meaning rates may not have too much higher to climb and a full-on repeat of last year remains a downside risk case, not our base case.
Brace for a bumpy final descent.
Investors came into the year pricing in a rapid decline in inflation without much pain in the labor markets. Central bankers have probably secretly been hoping for the same outcome. But we think this perfect ending is too good to come true. Instead, we expect slow but resilient growth and a slow but steady decline in core inflation. Much of that decline will come at the expense of corporate profit margins, leading more companies to consider layoffs as their stocks struggle. At the same time, we continue to see a number of compelling investment opportunities. Assets like high yield credit and loans, which rely on economic growth without being too sensitive to higher rates, are among our preferred asset classes.
All market and economic data from Bloomberg, FactSet and Morningstar.
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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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