Asset Managers Publish Mid Year Outlooks

Financial institutions have published their mid-year outlooks after the first six months of 2023. Despite significant hiccups like the regional banking crisis and more rate hikes, markets performed reasonably well, rising over 15% since Q4 2022 lows.

However, many institutions are skeptical about this exuberant optimism, pointing out persisting risks.

The largest ETF provider, Blackrock’s iShares, sees 1H23 as one with opposing narratives. An AI boom drove the market rally, pushing seven out of the eleven S&P GICS sectors into the green, while the labor market remained robust and inflation moderated slightly. However, they acknowledge that excess saving rates have fallen – especially in lower-income households, while the manufacturing sector slowed down due to tightening credit conditions.

Gargi Chaudhuri, Head of iShares Investment Strategy, believes that 2H223 performance will come down to 3 factors: the duration of the Fed’s pause, market focus on corporate profitability, and the growing role of fixed income in portfolio construction.

Meanwhile, J.P. Morgan (JPM) believes that a U.S. recession seems more likely than not by the year's end. They warn their clients don’t own enough European and Chinese equities, owing to a home country bias.

The bank singled out these two markets as European equities show impressive momentum in economic growth and corporate earnings, while their Chinese counterparts offer reasonable valuations and policymakers turn to more market-friendly practices. The firm concludes the outlook with a warning about concentrated stock risk, as recent regional bank failures show the risks, even when diversified within the sector.

For a $70b tech-focused investment management firm Coatue, breadth remains one of the main problems. In its latest macro keynote, the firm pointed out that Tech is almost single-handedly floating the yearly returns, while „old economy“ sectors like Energy, Financials, Healthcare, Staples & Utilities are all in the red.

Just seven tech stocks (Microsoft ($MSFT), Nvidia ($NVDA), Alphabet ($GOOG), Apple ($AAPL), Meta ($META), Amazon ($AMZN), Tesla($TSLA) are responsible for 85% of YTD's S&P 500 return.

Like iShares, Coatue acknowledges the polarized state of the market, quoting macroeconomic uncertainty, high valuation, and the above-mentioned poor breadth as weighing factors. However, a possible AI supercycle, economic resilience, and management teams that have been on alert provide potential tailwinds.

Looking forward, they conclude that the era of free money is over and that growth at all costs must be replaced with profitable scaling. Since 2022, money-losing companies have declined the most (-58%) and have been slowest to recover (+11%). Capital-driven growth is past and must be replaced with innovation and superior execution.

Morgan Stanley (MS) expects a slowing and divergent economy owing to persistent inflation and tight monetary policy by central banks. Their research team believes investors will be challenged to find opportunities that earn more than the risk-free rate of return, which is now over 5.2%.

“This means hard choices for investors,” stated Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research. Although he cautioned about equities and high-yield bonds in developing markets, he believes investors could find underappreciated opportunities there.

Morgan Stanley is looking into agency mortgage-backed securities, pointing out that yield differences relative to Treasuries are near where they were in 2008, with a critical difference in lending standards then and now.

“With valuations near 2008 levels, and expectations of declining U.S. government bond yields, total returns may be simply too attractive to pass up,” Sheets added.

It is worth noting that Morgan Stanley paid a $3.2B fine for its role in misrepresenting the risks of mortgage-backed securities, contributing to a 2008 recession.

The largest UK-based active-asset manager Abrdn ($ABDN), formerly Aberdeen, expects persisting stresses in the banking sector but without a systemic financial crisis. Regarding inflation, they expect a sharp drop, driven by energy base effects and lower food inflation – reaching close to policymakers' targets by late next year.

Yet, they anticipate monetary policy to loosen before that, with rate cuts as early as Q1 24. Before that happens, the European Central Bank (ECB) could hike rates once more, while the Bank of England (BoE) could at least twice more. After the Bank of Japan (BoJ) “shocked” markets with a bond yield shift, Aberdeen believes they will allow the 10-year bond to trade up to 75 basis points.

Wellington Management, a $1.4T independent investment management firm, shares a similar outlook. They expect the BoJ to pivot to tighter policy, potentially dropping their negative-rate narrative.

Wellington quotes the lack of independent thinking among central banks as an issue during high inflation. As major central banks follow the Fed, late-cycle dynamics for the US economy suggest that the Fed is near the end of its tightening cycle.

“As long as the US banking crisis doesn’t morph into a global banking problem, other countries quickly following the Fed’s response to the current problem will once again face consequences: to name one, they will be more likely to embed high medium-term inflation,” stated John Butler, Wellington’s Macro Strategist, adding that the unwarranted policy convergence could result in higher risk premia in the long end of yield curves in various countries.