Market outlook: equities have continued to shine, but macro challenges remain
Financial markets served up more plot twists than a complex murder mystery in the first eight months of 2023. We take a closer look at what the coming quarter could bring.
From the U.S. debt ceiling to the regional banking crisis, 2023 is likely to be remembered as anything but uneventful. Even then, uncertainty remains high: Contagion fears relating to fresh signs of weakness in Mainland China’s property sector continue to linger and it’s still unclear when the U.S. Federal Reserve (as well as its peers) will exit wait-and-see mode and hit pause on interest-rate hikes.
Despite the ambiguity that has more or less defined the trading environment, financial markets—particularly equities, and specifically, U.S. stocks—have done well year to date, exceeding expectations. That said, whether this positive streak could continue is anyone’s guess.
Market returns year to date in USD terms (%)
Unsurprisingly, the debate within our team continues to be lively and constructive. The bulk of our discussion, however, centers on three key points.
1 Recession postponed, not canceled
Our macro view hasn’t changed: While most economies have avoided a recession so far, we’re of the view that a contraction will occur in many parts of the world over the next 12 months. Broadly benign financial conditions and the rotation of consumer spending from goods to services (supported in part by the continued drawdown of excess savings accumulated during the pandemic) have underpinned growth, but we expect many of these tailwinds to start to dissipate as the lagged effects of cumulative rate hikes begin to affect the real economy.
We expect major economies to slip into a recession in the latter part of 2023 and early 2024; that is our baseline view. While we can foresee a scenario where the actual contraction turns out to be shallow and relatively brief, our base case is that a technical recession is the most likely outcome.
2 The stock market is not the economy
Is the stock market an indicator of where an economy would be in a few months? While there may be a correlation between stock market performance and economic strength, the stock market is not the economy. This explains why U.S. equities have been trending higher, supported by a healthy earnings picture, price momentum, and optimism about the artificial intelligence sector while forward-looking economic indicators flashed red. It also explains why we’ve retained our overweight stance to equities at this point. That said, we’re keeping an eye on the macro environment and will be prepared to change our views once evidence of an imminent economic slowdown mounts.
Asset class overview
Asset class overview
We have an overweight stance to equities, driven by consumer strength, outperformance from corporate earnings, and strong price momentum. Recessionary pressures and unfavorable valuations relative to fixed income, however, are the key risks to this view.
Broad equity
Broad equity
- Easing inflation and a resilient labor market have supported strong consumption in the United States. This asset class is also benefiting from favorable price momentum relative to global equities. In terms of sectors, we have a preference for growth stocks over defensive stocks.
- We’re underweight in non-U.S. assets as a result of ongoing strength in the United States. We believe emerging-market economies and Europe could face headwinds due to Mainland China’s lackluster reopening and its associated impact on global trade.
Regional/sector-specific equity
Regional/sector-specific equity
- We continue to be overweight in Japanese equities. The Bank of Japan's dovish monetary policy relative to the rest of the developed world, a favorable fundamental picture, and a renewed corporate focus on shareholder value are factors that are supportive of the asset class.
- We have an underweight stance to Chinese equities because the economic recovery on the back of Mainland China’s reopening has lost momentum and we expect growth to be subdued for the remainder of the year. Insufficient policy support and further regulatory reform are two key risks that we’ll continue to monitor in this market.
- In our view, emerging Latin American equities present an attractive alternative to emerging Asian equities because they’re largely driven by favorable fundamentals such as valuations and earnings.
Fixed income
Fixed income
- We’re overweight in emerging-market debt, driven by strong foreign exchange reserves, positive sovereign debt trends, and elevated spreads relative to U.S. corporate high yield.
- In light of the weaker-than-expected reopening in Mainland China and an uneven property market recovery, we’ve moved Asian bonds from overweight to neutral.
Private markets
Private markets
- In our view, elevated interest rates are likely to keep a lid on valuations within the real estate space. The office segment continues to face challenges from decreasing occupancy rates and limited refinancing options.
- Tight credit conditions, amplified by the failure of Silicon Valley Bank, shifted lending from the public markets to private markets with private debt being a beneficiary of asset growth. In relative terms, the private credit space can offer attractive yields amid the high-rate environment.
- Within agriculture, higher production volume is helping buoy crop prices amid elevated production costs, which are expected to decline in 2H 2023.
3 The great reopening in Mainland China that wasn’t
The third theme that has sparked much discussion within our team has to do with Mainland China’s economic performance since its reopening at the start of the year. Investors had expected 2023 to be a banner year for the Chinese economy, having assumed that the reopening would unleash pent-up consumer demand and boost growth. Unfortunately, the scenario didn’t play out as uncertainty relating to the country’s property sector kept a lid on consumer spending. In addition, the widely hoped-for large-scale stimulus package didn’t materialize. Analysts have been downgrading their growth forecasts for Mainland China this year on the back of a string of weaker-than-expected economic data. Unfortunately, the absence of a strong rebound in Mainland China is likely to be felt in Asia and Europe, and potentially, the broader global economy.
Uncertainty continues
In all likelihood, uncertainty surrounding Mainland China, the pace at which monetary policy evolves, and geopolitics will continue to drive market sentiment—and by extension, asset returns—going forward. While such an environment implies that a degree of caution is warranted, it doesn’t preclude the scope for upside surprises and opportunities. That said, the volatile trading environment has reinforced a tilt toward more defensive and higher-quality assets—at least for now.
Model inputs are factors in Manulife Investment Management research and are not meant as predictions for any particular asset class, mutual fund, or investment vehicle. To initiate the investment process, the multi-asset solutions team formulates five-year, forward-looking risk and return expectations, developed through a variety of quantitative modeling techniques and complemented with qualitative and fundamental insight; assumptions are then adjusted for economic cycles and growth trend rates. The charts shown here may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and are only as current as of the date indicated. There is no assurance that such events will occur, and if they were to occur, the result may be significantly different from that shown here.
The information in this material, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.
This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any investment products or to adopt any investment strategy. It is not possible to invest directly in an index. Past performance does not guarantee future results.
Important disclosures
Model inputs are factors in Manulife Investment Management research and are not meant as predictions for any particular asset class, mutual fund, or investment vehicle. To initiate the investment process, the multi-asset solutions team formulates five-year, forward-looking risk and return expectations, developed through a variety of quantitative modeling techniques and complemented with qualitative and fundamental insight; assumptions are then adjusted for economic cycles and growth trend rates. The charts shown here may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and are only as current as of the date indicated. There is no assurance that such events will occur, and if they were to occur, the result may be significantly different from that shown here.
The information in this material, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.
This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any investment products or to adopt any investment strategy. It is not possible to invest directly in an index. Past performance does not guarantee future results.
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