Ever-higher chances of recession across many markets, combined with the potential for further knock-on effects of policy tightening, demand a measured and careful response from investors.
In some major economies, these risks seem to be materialising already, with Europe likely to lead the pack into recession, warns abrdn.
“Most economies are operating well above their capacity,” said Jeremy Lawson, the firm’s chief economist. “Inflation is very high. Not just headline rates, not just because energy and food price inflation are high, but across the board.”
However, he also sees important differences across the global economy. In China, for example, underlying inflation is very subdued.
“This is allowing the authorities to loosen policy at the same time as policy is being tightened nearly everywhere else,” explained Lawson.
As a result, abrdn expects to see the Chinese economy pick up speed from here, especially given how been weak it has been over the last 12 months. “[This won’t be] boom times, not enough to rescue the global economy, but certainly a very different outlook,” Lawson added.
Positioning for a mixed outlook
Such optimism suggests that beyond the firm’s cautious central case are potential alternative scenarios.
These might range from supply side recovery to a savings run down from individuals or corporates, helping to shape asset allocation.
“We believe we should be setting up our portfolios for that cautious central case, but also ensuring some exposure to things that would benefit from the rosier outcomes that might come if that central case is wrong,” said Richard Dunbar, head of multi-asset research at abrdn.
Within equities, he is seeing some valuation protection in some areas of the emerging markets, particularly in Asia, based on valuation and relative macro attractiveness.
However, he also doubts whether the impact of the recession on profits and cash flows – and therefore dividends – is being reflected in the fall in equity markets.
“The last earnings season was a strong one. We feel that the potential risks to earnings are not reflected in many equity markets. We are underweight developed market equity,” said Dunbar.
A selective approach is also warranted for real estate, he believes, with a particular focus perhaps on residential and logistics as areas that can weather storms better than other segments.
In terms of currencies, meanwhile, abrdn still favours the US dollar, but believes it now offers less valuation opportunity.
By contrast, bonds are pricing in the environment a little better.
“We are looking to add to government bond positions in the portfolios,” added Dunbar. “In terms of credit… we’d prefer to be lending to high quality credits at the moment, so prefer investment grade credit over high yield.”