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Inflation downturn will ease risk picture

Graphs on a computer screen

A brighter international outlook is emerging, especially thanks to the prospect of large declines in inflation. Yet we still expect a mild recession during 2023, with a recovery starting in the second half of the year. We believe that this outlook is discounted in financial markets, with bond yields at more normal levels and equity valuations in line with historical averages. Despite prospects of a brighter outlook, because of the impending slowdown in growth and earnings we are maintaining a neutral allocation between asset classes in our portfolios.

Valuations and stock market performance

Short-term downward adjustments in earnings forecasts and rising share prices justify a cautious approach to stock markets in the near future. However, assuming that our main growth scenario proves correct, we are approaching the point where it will be time to look ahead towards the next phase. Earnings growth should rebound during the second half of 2023, which will probably coincide with the end of central bank tightening. The long-term stock market outlook appears hopeful.

Allocation

The past quarter saw a strong recovery in capital markets, bringing both stock and bond valuations and investor positioning into more neutral territory. Given these conditions, we find it appropriate to have portfolios that are close to neutral in terms of risk.

Being close to neutral means that we expect to benefit from risk premiums and that our portfolios will generate positive returns in the coming period. This is synonymous with corporate bonds providing higher returns than government bonds and stocks providing higher returns than corporate bonds over a somewhat longer time horizon. We are not further increasing our proportion of equities, because of the impending economic downturn combined with neutral valuation signals and the fact that bonds have an attractive expected return, since we believe that high bond yields will fall. This will also serve as a stabiliser against possible corporate earnings and cyclical disappointments.

Theme articles

This February 2023 issue of Investment Outlook also includes two theme articles:

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