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Wealthify's Investment Outlook Q4 2023

DIVERSIFICATION KEY AS UNCERTAINTY PREVAILS

A patient and diversified approach is key to increasing potential sources of return while helping to protect capital. Higher-for-longer interest rates are a reality, which means diversification and high-quality assets remain a priority for Plans. 

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Developed market economies (particularly the US) have proved more resilient to interest rate hikes than expected. And, even though consumer spending and labour markets have remained strong, we remain cautious about the outlook for riskier asset classes.

Our diverse approach means Plans have coped well with market ups and downs this year, and are positioned to potentially benefit from several sources of returns for the rest of 2023. We continue to be wary of the many risks facing markets, preferring bonds to shares due to the declining outlook for growth and corporate earnings.

Our Plans lean increasingly towards more defensive share markets, as the impacts of tighter financial conditions begin to wear down consumers, the economy, and – eventually – company earnings and share prices. To achieve our long-term goals, patience could be required while remaining invested in a sensible and risk-conscious way.

We continue to see the ‘soft-landing’ scenario – where inflation falls back to or below target without causing economic downturn – as being extremely unlikely. History shows us that monetary policy would have to be balanced perfectly to achieve this optimal outcome, and that economic drivers gather both positive and negative momentum.

In this case (with much higher interest rates), consumer spending and employment are much more likely to continue and gather pace — as opposed to stopping at the exact point of a soft landing. Thankfully, there have been plenty of recessions in the past that haven’t damaged the long-term returns that markets offer.

Winston Churchill once said to “never let a good crisis go to waste” and, with that in mind, we hope to take advantage of any recessionary outcome by purchasing shares at discounts. Even though we don’t know when this will be, we are actively looking for pricing opportunities.

For now, we’re favouring longer maturity bonds because they offer strong risk and reward as interest rates, inflation, and growth retreat — and investors look for safe-haven assets. We expect the cost-of-living squeeze to eventually stunt growth, inflation, and the labour market, leading to a situation with a moderately lower interest rate.

Although we’re not there yet, we do think an economic slowdown is on the horizon (and necessary to bring inflation firmly under control). Taking all this into account, we feel our cautious approach is justified, as we could see further cracks emerge due to tightening economic activity.

Top Risks

  • Global Recession: Despite a delay, central banks’ steep interest rate hikes have heightened the risk of a greater-than-expected economic and corporate profit downturn.
  • Debt Crises: Geopolitics, high inflation, and errors with fiscal policy (how the government spends and taxes to influence the economy) increase the risk of credit downgrades and crises fuelled by debt sustainability concerns.
  • Russia Ukraine Crisis: With no end in sight, the threat of escalations remain as the war continues.
  • Stagflation: A full cut-off in gas supplies to Europe would fuel an energy crisis, inflation, and a deeper recession. Rising oil prices – due to production costs by the Organization of the Petroleum Exporting Countries (OPEC) and the Middle East crisis – pose a more global threat to inflation. Higher rates would be needed to cool this at the cost of lower growth (stagflation).
  • China: Regulatory crackdowns and property market troubles remain an issue. Relations with the US remain an ongoing threat to the global economy.
  • Climate Change: Increasingly disruptive impacts on economic activity and supply chains are a threat to growth — and may drive further inflation.

Good things come to those who wait

While inflation appears to have peaked, there remains considerable uncertainty surrounding the outcome of one of the steepest rate hiking cycles in history. As a result, we’ve diversified our Plans as much as possible, taking advantage of improved bond yields while maintaining a healthy allocation to alternative assets such as infrastructure.

We’ve favoured more established share markets as a defence against riskier ones, keeping a reserve of short-term fixed income assets which can be used for the purchase of shares at attractive prices.

Although this may mean missing out on the odd false share rally, we firmly believe the market and global environment is one that requires caution — and we remain ready to take advantage of attractive pricing opportunities when they present themselves.

INVESTMENT OUTLOOK TABLE Q4 2023

Outlook Key

Positive

Neutral

Negative

United Kingdom

Both large and small UK companies generate significant amounts of their earnings offshore (and are historically cheap). Low valuations and defensive qualities are favourable in a slowing economy.

United States

We’re investing in US equities as they offer access to more resilient, diversified, and defensive business models and sectors. Despite valuations still being on the high side, quality shares are attractive as negativity increases.

Europe ex United Kingdom

Restrictive rates and energy risks remain a threat to the region’s economic growth. We don’t think the risk of a deeper downturn are currently priced in making the region relatively unattractive.

Japan

Japan’s economic environment has shown signs of improvement. Easy monetary policy – which increases the supply of money usually by lowering interest rates – has also led to a strong devaluation in the yen. The possibility of a sustained recovery is decent and, with a severely devalued yen, we are mildly positive.

Emerging Markets

While Emerging Markets appear to be in decent shape (in terms of both pricing and underlying fundamentals), they are likely to suffer more in the event of a global recession. In addition, governance and geopolitical issues in China have increased our negative stance.

Asia Pacific ex Japan

China remains central to the investment case for this region, with governance, geopolitical concerns, and property market woes increasing our negativity.

Shares Outlook Rationale
Region Current Quarter Why the outlook is what it is
United Kingdom Both large and small UK companies generate significant amounts of their earnings offshore (and are historically cheap). Low valuations and defensive qualities are favourable in a slowing economy.
United States We’re investing in US equities as they offer access to more resilient, diversified, and defensive business models and sectors. Despite valuations still being on the high side, quality shares are attractive as negativity increases.
Europe ex United Kingdom Restrictive rates and energy risks remain a threat to the region’s economic growth. We don’t think the risk of a deeper downturn are currently priced in making the region relatively unattractive.
Japan Japan’s economic environment has shown signs of improvement. Easy monetary policy – which increases the supply of money usually by lowering interest rates – has also led to a strong devaluation in the yen. The possibility of a sustained recovery is decent and, with a severely devalued yen, we are mildly positive.
Emerging Markets While Emerging Markets appear to be in decent shape (in terms of both pricing and underlying fundamentals), they are likely to suffer more in the event of a global recession. In addition, governance and geopolitical issues in China have increased our negative stance.
Asia Pacific ex Japan China remains central to the investment case for this region, with governance, geopolitical concerns, and property market woes increasing our negativity.
Shares Total We are continually underweighting shares because of the potential for greater-than-expected earnings disappointments due to a deteriorating economic outlook.

Total

We are continually underweighting shares because of the potential for greater-than-expected earnings disappointments due to a deteriorating economic outlook.

United Kingdom

UK government bonds (gilts) have been through a sustained period of negative performance, as rates increased rapidly on the back of soaring inflation. With much of the rate hiking cycle behind us, gilts offer attractive growth potential and low risk.

United States

US government bond yields have increased dramatically over the past year. We think they offer good potential for growth and protection in the case of a recession. With much of the rate hiking cycle behind us, little risk for negative movement remains.

Europe ex United Kingdom

We continue to monitor the outlook for this asset class against a very uncertain geopolitical and economic backdrop, where strong European Central Bank (ECB) interest rate hikes have increased the risk of policy error. As a result, we remain neutral.

Japan

Japanese bonds offer little income and remain severely distorted due to the Bank of Japan’s (BoJ) “Yield Curve Control” programme. While the BoJ might alter this program, there is little expectation for significant medium-term change.

Emerging Markets

While Emerging Markets government bonds offer a strong yield premium compared to Developed Markets, we remain slightly negative given the potential for a global recession, which would see investors flee to the safety of developed markets such as the US.

United Kingdom

Due to strong yields and broadly solid fundamentals within a more stabilised interest rate environment, we have a positive outlook on UK investment grade credit. The relatively uncertain interest rate environment, however, means we prefer short-dated bonds.

United States

Our outlook for US investment grade credit has dimmed somewhat, as valuations have realigned with long-term averages.

Europe ex United Kingdom

We remain slightly negative on European credit as a result of the many risks that remain, such as high inflation, weak growth, and geopolitical tensions.

Japan

Like Japanese government bonds, Japanese corporate bond prices are unattractive as they offer very little income.

Fixed Income
Government Bonds Outlook Rationale
Region Current Quarter Why the outlook is what it is
United Kingdom UK government bonds (gilts) have been through a sustained period of negative performance, as rates increased rapidly on the back of soaring inflation. With much of the rate hiking cycle behind us, gilts offer attractive growth potential and low risk.
United States US government bond yields have increased dramatically over the past year. We think they offer good potential for growth and protection in the case of a recession. With much of the rate hiking cycle behind us, little risk for negative movement remains.
Europe ex United Kingdom We continue to monitor the outlook for this asset class against a very uncertain geopolitical and economic backdrop, where strong European Central Bank (ECB) interest rate hikes have increased the risk of policy error. As a result, we remain neutral.
Japan Japanese bonds offer little income and remain severely distorted due to the Bank of Japan’s (BoJ) “Yield Curve Control” programme. While the BoJ might alter this program, there is little expectation for significant medium-term change.
Emerging Markets While Emerging Markets government bonds offer a strong yield premium compared to Developed Markets, we remain slightly negative given the potential for a global recession, which would see investors flee to the safety of developed markets such as the US.
Corporate Credit Outlook Rationale
Region Current Quarter Why the outlook is what it is
United Kingdom Due to strong yields and broadly solid fundamentals within a more stabilised interest rate environment, we have a positive outlook on UK investment grade credit. The relatively uncertain interest rate environment, however, means we prefer short-dated bonds.
United States Our outlook for US investment grade credit has dimmed somewhat, as valuations have realigned with long-term averages.
Europe ex United Kingdom We remain slightly negative on European credit as a result of the many risks that remain, such as high inflation, weak growth, and geopolitical tensions.
Japan Like Japanese government bonds, Japanese corporate bond prices are unattractive as they offer very little income.
Fixed Income Total We are positive on bonds due to their improved prospect of returns and defensive nature in a slowing and negative economic environment.

Total

We are positive on bonds due to their improved prospect of returns and defensive nature in a slowing and negative economic environment.

Environmental

Companies focused on reducing their environmental impact often have a competitive advantage due to greater resource efficiency, leading to lower costs. They may also experience a lower risk of loss, due to stronger corporate governance and better management teams.

Global Real Estate

Global real estate offers attractive value, underpinned by improved rental income streams and high interest rates. Recent troubles in the banking sector, however, mean caution is needed.

Global Infrastructure

The long-term outlook for Global Infrastructure remains positive, with a global need for advancement and investment. The asset class also offers exposure to stable revenue streams, making it defensive in nature.

Alternatives Outlook Rationale
Region Current Quarter Why the outlook is what it is
Environmental Companies focused on reducing their environmental impact often have a competitive advantage due to greater resource efficiency, leading to lower costs. They may also experience a lower risk of loss, due to stronger corporate governance and better management teams.
Global Real Estate Global real estate offers attractive value, underpinned by improved rental income streams and high interest rates. Recent troubles in the banking sector, however, mean caution is needed.
Global Infrastructure The long-term outlook for Global Infrastructure remains positive, with a global need for advancement and investment. The asset class also offers exposure to stable revenue streams, making it defensive in nature.
Alternatives Total We are positive on alternatives over the long term.

Total

We are positive on alternatives over the long term.

Investment Table last updated 13/11/2023

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