Bonds to rise in 2023?

2022 was an extraordinary year for investors, to say the least. Ingmar Przewlocka, portfolio manager at Schroders, looks in the rear-view mirror and looks forward at 2023.

1. What challenges are the markets facing at the start of 2023?

"Inflation is still way above target in many countries, while economic indicators are beginning to point to a slowdown. This makes life very difficult for central banks. They need to raise interest rates because of high inflation, although they know that this will curb growth," says Ingmar Przewlocka, portfolio manager at Schroders. "This presents us with the first challenge: good news can sometimes be bad news. Where a strong employment figure used to be clearly positive in the past, we now have to take into account that a strong figure can be negative for the financial markets. Therefore, in addition to fundamental analysis, you now need to carry out a behavioural assessment of the markets, of how they will react to different economic signals. In this way, you can better position yourself for whatever the market actually does, rather than where the market ought to be going!"

"The second challenge is that both equity and committed bond investors suffer when there are higher interest rates and slower growth. Under "normal" circumstances, equity markets rise when bond markets fall, and vice versa. However, for investors who had spread their portfolio across these two asset classes, there was no place to hide in 2022. New bond investors were able to capture attractive opportunities later in the year, but those who started 2022 with a high exposure to bonds and equities did not have a good year."

"Caught on the horns of a dilemma between inflation and recession, the central banks are clearly prioritising the fight against inflation, which in turn will make a recession more likely. Fiscal policy makers, on the other hand, are actually taking the other view: they are trying to support their economies with tax breaks. While this is understandable in challenging times, it does not help with the issue of inflation. So challenge number 3 is that we are getting mixed signals; just look at how the UK bond markets reacted to policy measures earlier this year."

2. What did you do with your own money/investments in 2022? How are you yourself positioned for 2023 and the next few years?

"Although the economic picture is gloomy, we need to ask ourselves to what extent the markets have already priced in a recession. In other words, we need to be aware of pleasant surprises that could give investors reason to be more positive about risky assets. By the time a recession actually occurs, we may already have seen the bottom of the market," continues Ingmar Przewlocka. “We are therefore selectively positioned to benefit from any upturn in the equity markets in the short term.”

"We have recently become more positive on bonds. A number of central banks appear to be approaching the end of their interest-rate hike cycles in the near future. With some bond yields rebounding, there are attractive opportunities for selective investors." "Commodities were in the spotlight in 2022. We are still positive about this asset class, but we are taking into account the extremely high volatility of natural gas prices and the conflicting interests of OPEC+, the US, Europe and Russia. In the long term, we believe there will continue to be a structural shortage of commodities. We are therefore maintaining a position in energy shares in the long term, but in the short term it continues to be anyone's guess." "At the start of 2023 we believe that the focus on inflation and liquidity risks will gradually shift towards growth risks, as central bank measures begin to have an impact on economic activity. Therefore, the negative correlation between equities and bonds could re-emerge, and bonds could perform strongly in 2023, while equities may lose their sparkle. That would make 2023 a very different year to 2022."

3. Which regions and industries do you prefer?

"We have balanced exposure to the US and Europe. The US offers exposure to the quality, defensive and technology sectors. Europe, on the other hand, offers more in the value sectors: the price/earnings ratios are currently attractive compared to US equities."

"Within emerging markets, we prefer a selective approach to broad exposure. In 2022, for instance, we took a tactical position in Brazilian shares. They showed an upward momentum as the Brazilian central bank proved successful in its efforts to control inflation and the Brazilian real performed well despite political uncertainty." "Cyclicals underperformed in the first half of 2022 as investors were worried about growth, but early in the second half of the year there was a rotation from defensive to cyclical sectors and technology. If inflation cools off, the central banks take the foot off the pedal and growth is still stable, cyclical sectors could perform well. But if growth is disappointing, defensive sectors – and possibly also technology – might perform better."

4.Where do you see the world in 10–20 years and what opportunities can this offer investors?

"Generally, we do not structure our portfolios for such a distant time horizon. Financial markets are driven by information, so that even long-term issues can be priced into the markets in the short term. Apart from that, there are some strategic issues that we keep a very close eye on, such as the energy transition, digitalisation, climate change, geopolitical tensions and a more fragmented global economy and demographic trends (shrinking workforces in parts of Europe, Japan and China)."

5. One last thought?

"2022 was all about inflation, inflation, inflation. 2023 will be all about pivot, pivot, pivot. There is a lot of talk about central banks pivoting, but we expect two more pivot points in 2023: the reopening of China and a pivot point in the war between Ukraine and Russia. When exactly and how these pivot points occur in the middle of all other shifts (inflation, interest rates, commodity markets, corporate earnings, consumption, etc.), investors will have plenty to think about in the new year."

The content of this article was drawn up by Schroders. The views expressed in this article (and in particular the statements between quotation marks) are those of the author and not those of Keytrade Bank. This communication does not constitute investment advice or a recommendation, nor is it a financial analysis. No part of this communication may be interpreted as being information with any contractual value of any kind whatsoever. This communication is for information purposes only. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analyses that may turn out to be incorrect. Keytrade Bank cannot be held liable for any decision of any kind taken on the basis of the information included in this communication, nor for its use by third parties. Please seek more information before investing in financial instruments. This includes carefully reading the document "Overview of the key features and risks of financial instruments" in the Document Centre at keytradebank.be.