Where to invest as recession fears worsen

The production cut announced by OPEC+ last week, which will reduce oil output by more than 1 million barrels per day, is just the latest piece of bad news for the global economy. The cartel of oil-producing nations and allied producer Russia agreed to slash production during their latest meeting in Vienna. It's all in spite of lobbying from US President Joe Biden amid concerns of the political fallout as November’s US mid-term elections draw near.

At the same time, several US economic indicators are flashing red as housing purchases slow, consumer confidence falls to 30-year lows and global purchasing manager indices continue to sink.

And in the UK last week, we saw the new government’s calamitous decision to embark on a massive program of unfunded tax cuts – even as the government deficit sits at multi-decade highs. The ensuing selloff of government bonds (gilts) sparked a prompt response from the Bank of England and an eventual policy backflip from UK Prime Minister Liz Truss.

Amid a surge of recession fears for the US and Europe – and by extension, Australia – what does this mean for global investors across different asset classes? In the first of this two-part series, we talk to a couple of multi-asset managers about their current portfolio positioning and their 12-month outlook.

A "perfect storm" is brewing

Raf Choudhury, investment director, abrdn Asia Pacific Multi-Asset Investment Solutions, says his team has held a below-benchmark allocation to risk assets for much of 2022.

“We just don’t think that the risk-reward trade-off is sufficient given the economic and policy outlook,” he says.

Against a backdrop of what he describes as “multiple, reinforcing headwinds” for the global economy, he expects the US Federal Reserve’s rapid fiscal policy tightening to tip the nation into a recession by the second quarter of 2023.

“And even before the US recession hits, Europe faces the prospect of huge terms of trade, real income, and energy shock pushing the Eurozone economy into recession by Q4 of this year,” Choudhury says.

“The compounding effects of these various shocks means that what once looked like a series of distinct headwinds emanating in different places at different times, are now coming together into something like a perfect storm for the global economy.”

“Cash is king”

In terms of his team’s portfolio positioning, this sees them underweight on both equities and bonds while maintaining exposure to alternatives and increasing cash holdings.

“As the saying goes, in this type of environment, cash is king, especially given the higher cash rates we are seeing,” Choudhury says.

The path to “real cash flow resilience”

Anthony Golowenko, portfolio manager of MLC Asset Management’s multi-asset Capital Markets Research team, paints a similar picture.

“The overarching theme that we’re aligning our multi-asset portfolios to can be summed up in three words, ‘real cashflow resilience,’” he says.

In fixed income, they’re favouring shorter duration domestic and global credit assets and are underexposed to Australian and global all maturity nominal bonds.

Within their equity book, they’re neutral on broader stock exposures and are underexposed to global equities. Golowenko describes the portfolio as being overexposed to Australian large-cap and mid-cap stocks and to Quality companies from emerging markets.

“In Alternatives, we’re at target allocation, constructive on short maturity specialty financing, and are seeking out attractive risk-return opportunities supported by diversifying, resilient cash flows," he says.

"Bonds behaving badly"

The views of Choudhury and Golowenko differ slightly more when asked to nominate the asset class they’re most bearish on currently.

“We see continuing risks of ‘bond markets behaving badly’ and remain underweight in all maturity nominal bonds,” Golowenko says.

Detailing how this view is reflected in his team’s portfolios, he emphasises its focus on Quality and “capturing opportunities where we see risk being appropriately compensated.”

“We’re well beyond ‘lower, for longer, forever', we’re also beyond ‘there is no alternative’ to equities, where the full spectrum of opportunities is opening up with a potential role to play in this ‘real cashflow resilience’ positioning,” Golowenko says.

Bearish on junk bonds, broad emerging markets

Choudhury narrows his bearish call on bonds to the high-yield category and also nominates some areas of emerging markets among his team’s least preferred asset classes currently. On the latter, he points to high inflation, large current account deficits in some EM countries, and limited scope for policymakers to cushion economies.

“Earnings revisions remain persistently negative with more cuts in profit expectations to come. Margins are under pressure in a rising cost environment. Valuations remain on the cheap side, but a catalyst for valuations being realised is not there,” Choudhury says.

“We expect broad EM asset classes to underperform cash on a 12-month horizon but at a more granular level, opportunities to extract value exist across select markets.”

In high-yield credit assets, he says the widening of credit spreads reflects the tighter monetary conditions globally and the pricing-in of inflation risk. Further widening still could occur if default rates rise – as Choudhury’s team expects, tipping these to lift from 2% to 6% during this cycle.

“As a result, we have liquidated all our HY positions and across credit prefer investment grade,” he says.

Stay up to date with this series

Make sure you "FOLLOW" my profile to be notified when the second and final part of this series is published. In part two, our contributors will each discuss a favourite chart and outline one signal that investors can’t ignore moving into 2023.