CIO Insights 1Q23 summary: the return of 60/40 | Bahasa

Indonesia, 04 Jan 2023 - Very rarely in the history of financial markets have we seen both equities and bonds correcting so acutely and in tandem as what we’ve observed in 2022. However, with bond yields soaring above 5% and equity valuations having mean-reverted, the turn of the year presents a great starting point for investors to return to a traditional “60/40” portfolio (i.e. comprising 60% equities and 40% bonds). Heading into 2023, a strong labour market and absence of systemic imbalances in the US suggests that a recession, should it transpire, will be mild. Meanwhile, CPI data and Fed rhetoric suggests a moderation in policy tightening, with yields poised to retrace. Faced with the twin challenges of rising recession risks and still sticky inflation, we favour bonds over equities, considering the historical outperformance of bonds in a high-inflation/ low-growth environment, and the currently wide bond-equity yield gap.


Within the 60/40 portfolio, we look to DM IG credit for safe, liquid income generation, and have upgraded DM IG corporate bonds to Overweight in view of their generous yields and well-managed credit risks. In the equities space, the impact of subdued earnings forecasts due to recession risks will likely be partly offset by valuation expansion in an environment of falling yields. We maintain our preference for US over Europe in DM equities, while seeking opportunities in China’s reopening. We continue to look towards alternative investments such as gold and private assets as portfolio risk diversifiers in a volatile investing environment.


A summary of our top investment takeaways for the quarter is as follows: 


1. DM equities: Preference for US over Europe


US markets are marked with cautious optimism as investors await transmission of the Fed’s monetary tightening through the economy. Significant divergence is expected at a sectoral level – we have downgraded Consumer Discretionary and Materials in expectation of moderation in domestic consumption and economic momentum. We remain constructive on Technology and Communication Services given (1) resilient earnings momentum and strong operating margins, (2) markets have already priced in tightening financial conditions.


Across the Atlantic, the outlook for European equities remains cloudy given high inflation and tight monetary conditions, necessitating an Underweight view on the region. Nonetheless, bright spots can be found within the Pharmaceutical, Luxury, Energy, Technology, and Industrial sectors, in resilient companies with underlying strength.


2. Asia ex-Japan equities: Benefiting from China’s reopening


After a dismal showing in 2022 as China struggled to navigate its strict Covid measures, our expectations of a measured reopening are playing out. We reiterate our constructive view on China given positive government measures alleviating Covid-Zero policies, real estate sector challenges, and economic goals as predicted. The timing has materialised to dollar-cost average down – we are constructive on domestic oriented sectors at the forefront of the reopening ripple, e.g. A-shares, New Economy and e-Commerce platforms, China consumer brands, and beneficiaries of government fixed asset expenditures.


ASEAN economies are also expected to stay buoyant against the global slowdown, benefitting from the tailwinds of China’s reopening, alongside recovery in private consumption, tourism, and a pick-up in infrastructure spending. Overall, Asia ex-Japan provides fertile ground for dividend investing, through China large banks, Singapore REITs, and telecommunication firms.


3. Bonds: DM IG provides safe, liquid income generation


A surge in yields has increased the attractiveness of bonds, and opportunities have resurfaced in high quality fixed income. We upgrade DM IG corporate bonds to Overweight for the quarter ahead, with our bias toward high-grade credit markets premised on (1) attractive risk-reward given IG yields trading significantly above its 10-year average, (2) well-managed corporate indebtedness, (3) limited spread widening for IG bonds should a recession hit. The sweet spot remains with the 3-5Y duration segment for A/BBB credit.


4. Alternatives: Diversify with gold and private assets


After displaying its diversification benefit as one of the best-performing asset classes in a volatile 2022, we expect gold to continue shining as a safe-haven asset, and its performance to hold firm amid peaking bond yields and a normalising USD. Nonetheless, positive real rates and further rate normalisation remain significant headwinds for gold from a returns perspective.


Private assets provide varied yet complementary characteristics to a traditional 60/40 portfolio. Recent macroeconomic changes have brought about headwinds to private assets in the form of a challenging exit environment, falling company valuations, and rising borrowing costs. However, the private markets continue to offer attractive long-term investing opportunities such as future-proof innovations, floating rate private debt, and the systemic shift toward renewable infrastructure.


5. Commodities: Long-term growth and supply scarcity support energy transition metals


Commodity prices remain volatile amid demand headwinds and supply disruptions. Amid an otherwise soft global demand for metals, growing EV demand and government-led energy transition initiatives have reinforced robust demand for battery metals and materials. Meanwhile, limited supply from producing countries further supports our long-term view on select energy transition metals.


6. Thematics – Cybersecurity


This quarter, we delve into the theme of cybersecurity, an essential component for our world as it undergoes digital transformation. Cyberattacks are increasingly prevalent – loss of confidential data, intellectual property theft, and disruptions to business continuity are just a few examples of unsavoury outcomes of cybercrime. Cybersecurity offers an antidote to this growing problem. With a boundless addressable market and fast-growing demand, we believe cybersecurity will be one of the most important sectors in the future.






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