Seven ways to refresh your portfolio

When elephants dance

There is a saying, “When elephants dance, the mice get nervous.” Since Q1 2022, it was not elephants but central banks hitting the dance floor with new moves. After several decades of declining interest rates, central banks shook things up in light of soaring inflation. The US Federal Reserve (Fed) and other central banks began what would become the fastest rate hiking cycle on record. This had a profound impact on financial markets, with both stock and bond markets suffering significant corrections in 2022.

Markets started to recover in 2023, but most stocks and bonds have seen recent setbacks, driven by expectations that central bank rates are likely to stay elevated for longer. While this is indeed a challenge, we would note that the overall situation has improved for investors versus a few months ago. It is now fair to say that the economy is more resilient than expected, which is the reason for the new elevated-for-longer rate expectations. Importantly, however, earnings estimates are now improving and real wages are growing again in the USA. We now have greater confidence that rate hikes will not cause a US recession over the next 12 months. Growth in China has disappointed, but not to the extent that it changes the global picture. In fact, it may help reduce inflation in developed markets.

As a result, we have a more balanced risk-reward outlook for equities and have moved the asset class from least preferred to neutral. Bonds stay our most preferred asset class given the decline in inflation and the fact that central banks are coming closer to the end of the rate hiking cycle.

High conviction opportunities – Messages in Focus of the House View

As the economic environment remains fluid and market participants keep repricing expectations for the future path of interest rates, investors need to remain selective when it comes to taking on risk. Our Top Investment Ideas are designed to identify relevant opportunities. From our House View, we have identified seven Messages in Focus that can serve as guiding principles for investors. We introduced these seven messages in June’s Top Investment Ideas Alert, and have since updated them on a regular basis. In the latest iteration, and in the context of recent market developments, these Messages in Focus are:

• Manage liquidity as rates peak
• Invest in quality bonds and diverse income
• Look for equity laggards
• Position for USD weakness
• Diversify with alternatives
• Invest in infrastructure
• Go sustainable

Manage liquidity as rates peak

This is a new message as managing liquidity is becoming more important the closer we get to the end of the interest rate cycle. Interest rates are peaking in developed markets as inflation falls closer to central bank targets. Investors should therefore actively consider how to optimize yields on cash holdings, while attractive interest rates are still available. Investors typically hold a liquidity portfolio worth 2–5 years of expected net portfolio withdrawals. A combination of fixed term deposits, a bond ladder and select structured investment strategies can also help optimize yields and manage liquidity considerations. Assets in excess of 2–5 years of expected withdrawals should be invested in a diversified range of longer-duration financial assets.

Invest in durable and diverse income

This message has been modified, combining the previous “buy quality bonds” message and the “seek diverse and durable income” message. The idea behind this message is to lock in high interest rates for the longer term and to invest in strategies that provide an income stream for the longer term. Surprisingly robust economic data has boosted bond yields, providing investors with a good opportunity to lock in currently elevated rates for an extended period. In fixed income, we like opportunities in the 5–10-year duration segment in high grade (government), investment grade (including select senior financial debt), and sustainable bonds. Exposure to actively managed income strategies and yield-generating structured investments (for instance on dividend paying equities) can help investors take advantage of the breadth of opportunities.

Look for equity laggards

We now have a balanced overall outlook on global equities. Valuations are elevated but developed market economic data has proven better than expected, and AI offers long-term optimism. Since stock market gains have been relatively concentrated this year, we see opportunity in stocks, markets, and sectors that have lagged. In US equities, we prefer equal-weighted indexes to cap-weighted indexes. Regionally, we like emerging market equities, and India in particular. By style, we continue to prefer value over growth. Due to the more balanced return outlook for overall equities, we no longer highlight specific Supertrends under this message.

Position for USD weakness

The USD has regained ground in recent weeks, but we see limited upside from here, given high valuations and the Fed approaching an interest rate peak. Investors with excess USD holdings should therefore consider selling the currency’s upside in exchange for income. We have a preference for the EUR, NOK and AUD. We have turned neutral on the JPY.

Diversify with alternatives

Complementing traditional bond-equity portfolios with an allocation to alternatives can help diversify portfolios and potentially boost returns. Hedge funds can generate returns even in flattish markets. Meanwhile, private markets offer a variety of opportunities to earn income and grow wealth over time, including in private equity, private credit and real estate.

Invest in infrastructure

Businesses and governments have been focusing their spending plans on key areas linked to upgrading infrastructure and supporting the net-zero carbon transition—two secular growth drivers that enjoy substantial policy support in the USA and Europe. We think that global industrial stocks should continue to benefit from these dynamics in the short run, while longer-term allocations to infrastructure and greentech look well placed in this environment, too. Infrastructure-linked assets also often operate on long-term contracts tied to inflation.