Summary
Risk assets have further room to grow in the short-term given a still robust US economy and increasing market expectations of a soft landing. However, recession risk is higher over the next 6-12 months, especially on the back of tighter financial conditions.
Macro: Mild recession risk over the next 6-12 months
Recession risk is higher over the next 6-12 months, especially on the back of tighter financial conditions. We are currently in the “late” cycle and both monetary and fiscal policy tightening will likely curtail growth further. Any recession is likely to be concentrated in the developed market economies. As a base case, our Multi Asset Portfolio Solutions (MAPS) team does not anticipate the upcoming recession in the US to be very deep i.e. no significant contraction.
Asset allocation: Opportunistically “risk-on”
The current market environment is supported by a robust US economy and increasing market expectations of a soft landing. In Asia, the recent China policy stimulus is moving in the right direction, and there is optimism that policy effectiveness will improve in the coming months. Given this backdrop, our MAPS team believes that risk assets have further room to grow in the short-term investment horizon. However, if risk assets become overstretched, the team will dynamically allocate into safe haven assets and vice versa. While our MAPS team’s base case is for a mild recession 6-12 months from now, the team is opportunistically “risk-on” in their positioning.
Asset allocation views
Equities: Asian equities poised for medium-term outperformance
The team is constructive on Asia ex-Japan equities over the medium term, given resilient Asian exports and upward-trending economic data. Supportive policies implemented by Chinese leaders/regulators have stabilised the country's property market, and in turn the broader region. Valuations (12.1x P/E) remain cheap relative to other regional markets. While Asian equities will not be immune to global growth headwinds, the team expects valuations to trade range-bound as the global slowdown is concentrated in the developed economies. Improving China fundamentals should also help offset some of the volatility, making Asian equities less affected by a global recession and positioning it well for the longer horizon.
Bonds: US Treasuries remain attractive over a 12-month horizon
As global growth decelerates, most economies, particularly the US, are nearing the end of their rate tightening cycles. As such, our MAPS team expects that US rates have more scope to decrease than to increase, moving forward. Despite the hawkish pause by the Fed at its most recent meeting and the Fed Funds Futures market still pricing in a higher for longer rate scenario, our MAPS team believes that the odds of a recession have increased, and US duration is attractive over a 3-month horizon. Over a 12-month horizon, US Treasuries are attractive and will likely regain their roles as effective diversifiers, especially in a recessionary environment. Given the MAPS team’s base case of a mild recession over the next 6-12 months, spreads have room to widen significantly. We would expect HY spreads to widen more. IG credit may trade more range-bound as higher spreads are potentially offset by falling US yields.
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Currencies: US dollar still powered by US growth and high yields
The MAPS team is overweight the US dollar, based on expectations of “higher for longer” US rates and widening interest rate differentials. Various data indicators are also signaling resilient fundamentals and optimistic market sentiment. Additionally, the team recognises the counter-cyclical nature of the US dollar, which tends to outperform during a recession. Thus there is potential for higher performance from the US dollar over the medium term given the team’s expectations of a recession within the next 6-12 months.
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This is an extract of the 4Q23 Market Outlook. Click here to download the full report which includes a special feature “A stubbornly resilient US economy?”.
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