Multi-Asset Portfolio Perspectives: When will the fog clear?

Commentary, 27.04.2023
The good news first: Due to diminished correlations between bonds and equities, multi-asset portfolios finally offer substantial diversification advantages compared to single-variety portfolios. In addition, it is again possible to generate positive nominal returns with investments in money due on demand and in money market instruments.
However, this development also has its price, as more than a decade of extraordinarily expansive monetary policy has to be “normalized”. The main focus at the moment is therefore on the negative effects of an exceptionally rapid and extensive interest rate turnaround in the USA. While a rise in key interest rates of 475 basis points in just a little over twelve months made negative consequences for the real economy appear very likely, the extent of the instability of some US regional banks as a result still surprised some observers. Because although the liquidation of the Silicon Valley Bank (and Credit Suisse, as it were, as "collateral damage") seemed to have been digested, the First Republic Bank is another US bank that is currently in the focus of attention, whose possible restructuring leaves many more questions unanswered than expected.

Especially in light of the extremely dubious quality of its loan portfolio, the question is no longer whether this bank needs to be rescued, but by whom. It is very likely that the public sector will have to take on this task, with a bit of luck the big US banks might help again with an inflow of liquidity. Nevertheless, this event is likely to cause continued uncertainty and, in combination with a deepening fiscal crisis - keyword "debt limit" - could cause a lot of volatility in the coming weeks, especially on the US markets.

At the same time, the question of whether the inflation risks have decreased can be answered with a clear "yes". In principle, the decline in the broad inflation measures gives hope for a trend reversal, but the stickiness of the core inflation rates indicates a level shift, at least in the medium term. However, assuming a gradual stabilization of the economic situation, the inflation drivers on the demand side would be boosted again. Increased financing costs will in all probability dampen the supply side in the medium term, resulting in additional cost effects. In this respect, the probability of interest rate surprises in the euro zone is therefore significantly higher than in the USA, since the latter can point to a better consolidation path in this regard.
The logical consequence of these considerations is a portfolio allocation that tends to be much more defensive, combined with elements that protect against inflation. The possible risks from an ongoing banking crisis in the USA and an overly aggressively priced yield curve for medium and long maturities are too unclear. At the same time, based on current valuations, it seems unlikely that equities will be able to demonstrate attractive risk-based upside potential in the short term. US stocks in particular are currently expensive, and increased economic uncertainties clearly speak against overweighting. European equities are much more attractive in this regard, but higher interest rate risks represent a potential stress factor. Defensive dividend stocks of large-cap companies – preferably in Europe – should in any case be able to play a performance-driving role. On the bond side, high-quality corporate bonds once again stand out, but an entry into high-yield and emerging market bonds still seems premature.
Alternative investments, especially commodities, are an important addition, even in the current high-interest environment like last year, and should remain overweight. On the one hand for reasons of inflation protection and on the other hand against idiosyncratic risks. Gold in particular plays a central role in this context, since apart from systemic risks, potentially negative spillovers from military conflicts (Ukraine/Russia and China/Taiwan) are still very high.
In all likelihood, 2023 will still bring a few negative surprises, but the positive effects from the interest rate turnaround that has been initiated offer cause for hope.

Mag. Manuel Schuster, IMC

CEO&CIO, FAME Investments AG