It’s a gloomy time of year in more ways than one at the moment. Even the excitement of my recent move to a new house can’t distract from the literal and figurative darkness of January 2023. The war in Ukraine is dragging on and the specter of recession looms large, to name but two dark clouds over us all.

Just as a new house brings a fresh start, a fresh calendar year is an opportunity for active investors to look to the future. And as we peer through the present gloom, we see some causes for optimism. Following the poor performance and significant declines in equity and bond markets in 2022, we now see some attractive valuations. And I’m reassured that whatever comes next, we have the processes and teams to cope.

The last decade was dominated by the outperformance of US assets. We now see benefits to greater regional diversification.

Look Beyond the US
The last decade was dominated by the outperformance of US assets—both equities and bonds. We now see benefits to greater regional diversification. 

Within fixed income, a number of emerging markets (EM) are further along in the battle against inflation and have reasonably solid macroeconomic fundamentals. Given the high level of yields—particularly in local currency-denominated bonds—and the level of underinvestment in this asset class due to turbulence over the last decade, we see opportunities for 2023. Our EM debt team has highlighted local-currency bonds in Mexico, Brazil, Indonesia, South Africa, and a number of dollar-debt frontier markets such as Angola and Ivory Coast as being particularly appealing.

We're also starting to differentiate more within equities as regions outside of the US offer more compelling valuations. Underlying US margins, after a prolonged period of strong execution, are at record levels. As we've seen with the tech sector, cost pressures in the US are now making themselves apparent at a time when revenue growth is clearly starting to slow. Negative operating leverage—in which fixed costs comprise a greater portion of a company’s total cost structure while sales decrease simultaneously—is beginning to kick in. Yet Wall Street still expects 6-7% earnings growth for the S&P 500 Index in 2023, which seems optimistic. 

China on the Rise Again?
The rest of the world definitely looks more interesting, however, especially Asia. China is likely to accelerate quite strongly out of its extended period of strict COVID-19 lockdowns. Our Asian equities team expects a sharp recovery in consumer spending to kick in from the second quarter on, supporting domestic earnings in many sectors of the Chinese economy.

Lastly, a word on overall risk levels. While rate expectations are now more realistic and we expect interest-rate volatility to stabilize, we also expect liquidity to remain tight in the next few months. Combined with the risk of recession, we believe more pro-cyclical positions need to be balanced with lower allocations to US equities. It may be prudent to keep some dry powder for the opportunities likely to appear.

¹ Correlation is a statistical measure of how two investments move in relation to each other. A correlation of 1.0 indicates the investments have historically moved in the same direction; a correlation of -1.0 means the investments have historically moved in opposite directions; and a correlation of 0 indicates no historical relationship in the movement of the investments. 

S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.

Bloomberg US Aggregate Bond Index is composed of securities from the Bloomberg Government/Credit Bond Index, Mortgage-Backed Securities Index, Asset-Backed Securities Index, and Commercial Mortgage-Backed Securities Index. 

Important Risks: Investing involves risk, including the possible loss of principal. Fixed-income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Investments in the commodities market may increase liquidity risk, volatility and risk of loss if adverse developments occur. • Investments linked to prices of commodities may be considered speculative. Significant exposure to commodities may subject investors to greater volatility than traditional investments. Diversification does not ensure a profit or protect against a loss in a declining market. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political, economic, and regulatory developments. These risks may be greater, and include additional risks, for investments in emerging markets.

The views expressed herein are those of Schroders Investment Management (Schroders), are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. The opinions stated in this document include some forecasted views. Schroders believes that they are basing their expectations and beliefs on reasonable assumptions within the bounds of what they currently know. The views and information discussed should not be construed as research, a recommendation, or investment advice, nor should they be considered an offer or solicitation to buy or sell any security. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Schroders or Hartford Funds.

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