Prevailing Under Pressure

We Believe

  • Our baseline cyclical forecast includes shallow recessions and rising unemployment across large developed markets, with growth unlikely to bounce back quickly. Central bankers appear squarely focused on bringing inflation down.
  • The return potential in bond markets appears compelling given higher yields across maturities. We will look to maintain portfolios designed to be resilient across a range of economic, geopolitical, and market outcomes, and to be liquidity providers during periods of greater market stress.
  • In credit markets, we will seek to achieve a balance between near-term caution given the uncertainty and recession risks and a long-term focus on high quality, resilient assets. The gap between private and public asset valuations remains wide, but as private markets adjust and challenges become apparent across the corporate credit and real estate space, we expect to target a range of attractive opportunities.
  • We see downside risk for global equity markets, given starting valuations and earnings expectations that may not account for ongoing central bank tightening and increased recession risk. We also anticipate the more typical negative correlations between high quality bonds and equities will reassert themselves, thus improving the hedging and diversifying characteristics of core bond allocations

Economic Outlook

This is a critical time for investors and policymakers alike.

Geopolitical tensions, elevated market volatility, and the fastest pace of central bank tightening in decades are meaningful economic headwinds contributing to an unusually uncertain environment. We discussed these and other factors at length at our Cyclical Forum in September in Newport Beach.

We concluded that a recession is likely to strike across developed markets and that elevated inflation is likely to stick around. Central banks are in a miserable position, having to address inflation while growth is already at risk.

We see this as a time for caution and flexibility in portfolios, and yet higher yields are adding to the attractiveness of bonds. Investors can potentially earn higher income while pursuing resilience amid market volatility. We discuss the case for bonds – and review other assets – in the investment implications, further below.

As we worked toward these and other conclusions, we reminded ourselves of the concept of radical uncertainty, where uncertainty can’t be quantified by statistical distributions or probability-weighted average outcomes, but rather is unmeasurable and represents unknowable unknowns (see, for example, “King, Keynes and Knight: Insights Into an Uncertain Economy,” July 2016). As a result, although we discussed point forecasts for growth and inflation, we agreed that the range of possible outcomes was particularly wide.