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From a macro and market standpoint, the worst may be behind us, but we think it’s too early to wave the all-clear flag for risk in 2023. Tight financial conditions will be a headwind for most developed economies as central banks fight to bring inflation down, and we expect recessions in the US and Europe, though the severity is an open question. As suggested by the sharp rally in the fourth quarter of 2022, however, markets appear to be skipping the recession chapter of the story and moving straight to rate cuts and the benefits to risk assets.3 But even mild recessions mean negative earnings growth and pressure on equities and credit spreads.

Our outlook is a bit brighter when it comes to China and other EM. While we acknowledge the very real health risks that come with relaxing zero-COVID policies, we believe this shift will eventually unleash tremendous pent-up consumer demand for services, just as we’ve seen in other regions, and we expect positive spillover effects for the rest of emerging Asia and exporting countries in Latin America. Furthermore, we find that Chinese equity exposure has had a low correlation to other equity markets (FIGURE 1).



Chinese Equities Have Offered Uncorrelated Exposure
Rolling 24-month return correlation between MSCI China Index and MSCI World Index (local currency)

Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. MSCI China Index is a free-float adjusted market-capitalization index that is designed to measure equity market performance in China. MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. Sources: DataStream, Wellington Management. Chart data: 1/31/03-12/31/22.

Our Multi-Asset Views

OW = overweight, UW = underweight

Views have a 6-12 month horizon and are those of the authors and Wellington’s Investment Strategy Team. Views are as of 12/31/22, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities.

While our broad asset class views remain somewhat defensive, we’ve shifted our regional and subsector views to express a glint of optimism about where conditions are headed later in 2023. We maintain our moderately underweight view on global equities, as we don’t think valuations adequately reflect recession risk. But given our improved outlook for China and EM ex-China, we’ve raised our views there to moderately overweight and neutral, respectively. We’ve reduced our view on US equities to a moderate underweight and maintain our overweight view on Japan. We remain more negative on Europe, where consumers are still bearing the weight of high energy prices and domestically driven inflation, and where earnings downgrades may have further to go.

Turning to fixed income, we’re neutral on duration overall and favor US rates over Europe and Japan. The Federal Reserve (Fed) is leading the way on the inflation fight while the European Central Bank (ECB) has relatively more work to do. With US growth slowing, we think 10-year yields in the 3.5%–4% range look relatively attractive and believe high-quality fixed income will resume its potentially diversifying role. As for spreads (growth fixed income), we maintain our underweight view. Recession has historically led to poor credit returns on average and median spreads point to a poor risk/reward trade-off, even in a more benign economic scenario.

The risks to our generally defensive view include upside from a soft-landing scenario or a more effective exit from China’s zero-COVID policies. In both scenarios, however, the inflation problem doesn’t go away. In fact, it may get worse, leaving policymakers, if we take them at their word, an even more hawkish bunch.


Equities: Policy Weighs on Earnings but Looks Supportive for EM and Japan

We expect inflation to decline but remain above target in 2023, allowing central banks to stop tightening but not to cut rates. As noted, we think the market is leapfrogging straight to a recovery and underestimating the effects of restrictive policy on the economy and earnings. The breadth of equity earnings downgrades has accelerated in recent weeks, and expected margins have peaked. We expect further deterioration in macro variables to weigh on earnings expectations and don’t believe this outlook is adequately reflected in current equity valuations. We’ll need to see the downgrade process play out before we turn more favorable on global equities.

We expect a bumpy reopening in China as supply disruptions caused by absenteeism and strains on the healthcare system are all but inevitable. But we think consensus still underestimates the likely improvement in growth and inflation in 2023 as pent-up demand is released and financial conditions ease, with positive impacts on consumer-facing sectors in particular. We expect other EMs to benefit from China’s improvements, as well as from less of the sticky forms of inflation (wage- and shelter-driven) that we see in developed markets (DM), providing room for less-restrictive policy. EMs are pricing significant earnings declines for 2023, which, in contrast to DMs, gives us more comfort that the worst might be over for equities.

We funded our move to a neutral view on EM ex-China by reducing our US view to moderately underweight. The growth and inflation backdrop in the US remains problematic, and fiscal policy is more of a drag than in other regions; however, we think this growth backdrop isn’t reflected in valuations or earnings expectations. We also retain an underweight view on European equities as we think recession is still underpriced when it comes to company revenues and earnings—with real revenues expected to grow 2.1% in 2023. Energy-price declines have provided some relief, but risks are skewed to the downside as we expect supply shortages to persist through at least 2025–2026. Most importantly, with sticky core inflation in Europe, we think policy tightening risk is highest there, creating greater downside for financial conditions than in other regions.

The investment thesis for Japanese equities remains attractive in our view, with cheap valuations, a relatively benign macro environment, and supportive fiscal and monetary policy. We’re closely monitoring the Bank of Japan (BOJ) exit from yield-curve4 control, which we believe will happen gradually over the course of 2023. We think the structural case for stronger Japanese growth remains intact, with a more dynamic labor market, a surge in capital investment, and a large exposure to China’s exit from zero-COVID.


Commodities: Focused on Copper and Oil

We’ve upgraded our view on copper to moderately overweight. Inventories of copper and other industrial metals continue to drift lower, and we expect a significant increase in copper demand from China in the coming months thanks to the zero-COVID exit and incremental support for housing. Copper is very sensitive to demand from China, which accounted for 54% of global demand in 2021.5 On a more structural basis, demand for copper could accelerate globally as a result of the decarbonization process and the renewables, grid, storage, and electric-vehicle supply chains.

We maintain our overweight view on oil, where the roll yield6 remains positive despite recent declines. One driver of the recent oil-price decline was the plan to cap the price of Russian crude at US $60, which we continue to monitor. But with the oil price currently just above marginal cost assumptions, we believe it still constitutes good value.


Fixed Income: Expecting a Better Year for Returns in the US

With the BOJ having effectively joined the hiking pack, all DM central banks are now raising rates, reducing global liquidity, and slowing their economies. Yet conditions vary quite a bit from one region to another. In the US, markets have priced in the Fed’s current terminal policy rate of 5%, so we feel comfortable that 10-year yields of 3.5%–4% are reflecting slowing growth and inflation in the longer term. Despite market optimism about rate cuts by year-end, we think the Fed may need to hike rates further or keep restrictive policy in place longer to truly slay inflation, making recession more likely and lowering long-term yields.

The ECB adopted a more hawkish stance in December as the energy shock moderated and fiscal support proved to be a powerful offset. With core inflation high, wage pressures growing, and China’s reopening potentially fueling upside-demand risk, ECB President Christine Lagarde offered this warning: “Compared to the Fed, we have more ground to cover, we have longer to go.” Thus, we’re bearish on European sovereign rates. While the BOJ’s looser yield-curve control is an important step toward exiting quantitative easing, we see the process as moving gradually and think any rate rise will be contained.

As for spreads, valuations are at median levels and, therefore, not reflective of worsening credit conditions, even in a mild recession. For example, global high-yield spreads have averaged around 1,000 basis points7 in the past three recessions, and spreads are currently close to half that. Furthermore, tighter lending standards of late are suggesting wider spreads (FIGURE 2).

Setting aside our underweight view on spreads broadly, we favor a quality bias. One way we see to potentially express a quality bias without giving up yield is to favor EM sovereign debt (USD-denominated), about 50% of which is investment grade, over high yield. Our research indicates that EM debt has historically had a lower beta8 to global equities than high yield.



Tighter Lending Standards Bode Negatively for Spreads
US high-yield option-adjusted spread and Senior Loan Officer Survey

Past performance does not guarantee future results. An Option-Adjusted Spread (OAS) is a measurement tool for evaluating yield differences between similar-maturity fixed-income products with different embedded options. Sources: Bloomberg, Federal Reserve. Chart data: 2/29/98-12/31/22.



Upside risks to our views include soft-landing scenarios, in which the Fed (and other central banks) manages to decelerate the economy enough to moderate inflation without a significant impact on employment and consumption, avoiding recession. We could also see higher fiscal spending in the US, Europe, and China offset the drag from monetary-policy tightening. Lastly, the boost to global demand or to domestic consumption and services from China’s zero-COVID exit could be underestimated by the market.

Downside risks include the possibility that tightening financial conditions, operating with a lag, have a more negative impact on global employment, earnings, and output than expected, resulting in a deeper or lengthier recession. Other risks include a liquidity-induced financial accident that causes systemic risk across the market, such as what we saw in the UK pension crisis in 2022, and an escalation in the Russia-Ukraine war.


Investment Implications

Here are six things investors may want to consider:

  • Central-bank tightening still warrants caution on risk — We continue to focus on quality in DM equities as recession still looms, and earnings expectations remain too optimistic. We prefer companies with pricing power, long-term margin stability, and healthy balance sheets that can withstand inflationary pressures. We favor value-oriented sectors such as energy and materials.
  • Favoring a slight shift in China and EM exposure — However painful the process, reduced COVID-19 restrictions in China are likely to improve domestic conditions. We favor moving to a moderate overweight to China and expect a positive spillover effect from increased demand to EM equities ex-China.
  • Seeking to take advantage of regional divergence through active management — Central banks are at different stages of policy tightening, and China is actually easing policy now. We favor Japan for its still relatively loose monetary policy and better growth/inflation mix. Financials are likely to be the biggest beneficiaries of higher 10-year Japanese government bond yields. We think European equities remain vulnerable to drawdowns compared to the US and Japan.
  • Seeing more to like in bond yields than earnings yields — High-quality fixed income looks more competitive vs. equities from a yield perspective and could offer upside and diversification as growth slows.
  • Seeking potential inflation protection — While demand destruction in developed economies is a headwind, a supply/demand imbalance continues to support commodities. We favor industrial metals, especially copper, now that China’s COVID-19 restrictions are easing. We also think Treasury Inflation-Protected Securities9 breakevens remain attractive, as do some real assets.
  • Approaching credit cautiously — Spreads aren't particularly attractive given the higher risk of recession. That said, we see opportunities in structured credit, particularly in older-vintage non-agency residential housing, and in short-duration credit.

The views expressed here are those of the authors and Wellington Management’s Investment Strategy Team. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views, and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of 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 Wellington Management or Hartford Funds.

Talk to your financial professional about how you can position your portfolio amid market uncertainty.


1 Spreads are the difference in yields between two fixed-income securities with the same maturity but originating from different investment sectors.

2 Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.

3 Risk assets refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate, and currencies. Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.

4 Yield curve is a line that plots interest rates of bonds having equal credit quality but differing maturity dates; its slope is used to forecast the state of the economy and interest-rate changes.

5 Sources: Wood Mackenzie, JPMorgan; as of 11/30/22.

6 Roll yield is the amount of return generated in the futures market after an investor rolls a short-term contract into a longer-term contract and profits from the convergence of the futures price toward a higher spot or cash price.

7 A basis point is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indices and the yield of a fixed-income security.

8 Beta is a measure of risk that indicates the price sensitivity of a security or a portfolio relative to a specified market index.

9 Treasury Inflation-Protected Securities are Treasury bonds that are adjusted to eliminate the effects of inflation on interest and principal payments, as measured by the Consumer Price Index (CPI).

Important Risks: Investing involves risk, including the possible loss of principal. Security prices fluctuate in value depending on general market and economic conditions and the prospects of individual companies. • Foreign investments may be more volatile and less liquid than U.S. 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 such as China. • 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 the investors to greater volatility than traditional investments. The value of such instruments may be volatile and fluctuate widely based on a variety of factors.  • The value of the underlying real estate of real estate related securities may go down due to various factors, including but not limited to, strength of the economy, amount of new construction, laws and regulations, costs of real estate, availability of mortgages and changes in interest rates. • Fixed-income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. • Loans can be difficult to value and less liquid than other types of debt instruments; they are also subject to nonpayment, collateral, bankruptcy, default, extension, prepayment and insolvency risks. • The value of inflation-protected securities (IPS) generally fluctuates with changes in real interest rates, and the market for IPS may be less developed or liquid, and more volatile, than other securities markets.

Diversification does not ensure a profit or protect against a loss in a declining market.

Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.

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About The Authors
Nanette Abuhoff Jacobson Headshot
Managing Director and Multi-Asset Strategist at Wellington Management Company and Global Investment Strategist for Hartford Funds

Nanette Abuhoff Jacobson consults with clients on strategic asset allocation issues and works with investment teams throughout Wellington to develop relevant investment solutions across asset classes.

Author Headshot
Multi-Asset Strategist at Wellington Management
Author Headshot
Investment Strategy Analyst at Wellington Management

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