Key points
- Market volatility to continue due to inflation concerns, recession fears and rising interest rates
- Risk of recession in the U.S. (the world’s biggest economy) in the second half of 2023
- Bonds are likely to do well after a challenging 2022
- Cornerstone portfolios follow a very disciplined process to manage risk and adapt to changing market conditions
Continued market volatility
Recession fears, inflation and central bank tightening, are expected to drive continued market volatility in 2023. Share markets have stabilised recently amid expectations inflation may be peaking, however, short-term market volatility is likely to remain, given investors’ responses to inflation data and central bank interest rate decisions. It’s an environment where good economic news can be construed as bad for markets and vice versa.
Risk of U.S. recession
The main uncertainty is the outlook for the U.S. economy. We believe the speed and size of U.S. rate hikes create the risk of a recession in the world’s biggest economy by the second half of 2023. While a deep recession could trigger a larger-than-expected selloff, we feel a slowdown or mild recession are the two most likely outcomes. Recent indications suggest U.S. inflation can trend lower through 2023, though the key question is by how much. A sustained move lower would ease fears around excessive rate hikes and a deep recession. However, until this becomes apparent, markets are likely to remain volatile and range bound.
What impact might a U.S. recession have on the Australian economy? There’s an old saying that when the U.S. sneezes, the rest of the world catches a cold. This is because the U.S. economy accounts for around a quarter of the global economy. So, it’s likely then that softer U.S. growth, just like softer Chinese growth, will have an adverse effect on our own economy, though just how much of an effect remains to be seen.
Bonds likely to do well
After experiencing their worst year of returns on record in 2022, government bonds are likely to rebound in 2023 as long-term yields decline on recession risks. Bond yields have an inverse relationship with bond prices, meaning that when yields fall, prices rise and vice versa. Patient bond investors we believe will be rewarded in 2023.
How Cornerstone portfolios adapt
The good news is that the Cornerstone portfolios have been constructed to respond to changing market dynamics in real-time, to effectively manage risk and to take advantage of market opportunities as they arise.
It’s important also to remember that whilst we cannot control what markets do, we can control how we react to them. The strategy for the Cornerstone portfolios is to ignore the noise and remain focused on the investment process. Long-term asset allocation is the main anchor for the portfolios.
Recently, we increased the portfolios’ bond exposure, which we expect to reduce volatility if recession risks continue to rise. We also modestly increased our exposure to Metrics Credit, a strategy that invests in assets that are less sensitive to interest rate movements.
Our portfolio managers are committed to achieving long-term outperformance for investors and remain both patient and alert for any investment opportunities.
