CIO update by Philipp E. Bärtschi, CFA, Chief Investment Officer at Bank J. Safra Sarasin

Macro outlook – The recession year 2023

Many years feel historic. The year 2022 actually was. Investors ex-perienced the highest inflation and the fastest and strongest rate hiking cycle in 40 years. For the first time in more than 100 years, both equities and long-term bonds fell more than 20% during the year. You had to look very hard to find an asset class that ended the year on a positive note. This was driven by an unusual combi-nation of very expensive valuations at the beginning of the year, high inflation and aggressive monetary tightening by global central banks. In this environment interest rates rose to their highest lev-els since the global financial crisis within just ten months – a de-velopment that normally takes place over a period of several years.

The adverse effects on the overall macroeconomic picture are ac-cordingly strong: the housing market is suffering, industrial pro-duction and new orders are continuing to decline, sentiment re-mains depressed, and purchasing managers' indices are still be-low the contraction threshold. Economic activity in Europe has also slowed down, but has been better than expected due to the ex-tremely mild winter so far and a surprisingly strong service sector.

Looking ahead, we are faced with global central banks which, in the face of all these developments, continue to tighten monetary policy to combat persistently high inflation rates. Thus for they re-main undeterred by an imminent recession in Europe and the USA, which we expect to happen this year and undeterred by a complex mix of geopolitical risks in Europe and Asia, which will continue to accompany us in the months ahead. In this mixed environment, central banks will have to prove their credibility. Although we ex-pect headline inflation to decline further in the coming months, thus taking some pressure off central banks, it will still be with us for quite some time.

One development that could change the overall global picture for the better is China's surprisingly rapid departure from its zero COVID policy. While the extremely high COVID case numbers make the short-term outlook highly uncertain, Beijing's stimulus measures and rising consumption should lead to a strengthening of not only regional but also global economic growth over the course of the year.

Bonds – Here to stay

Global central banks are likely to continue raising their policy rates for the time being due to high inflation rates and against the back-drop of a still solid labor market, and thus rates should remain at high levels in 2023. Contrary to market expectations, we do not expect the US Federal Reserve to lower policy rates as early as this year. Interest rates are therefore unlikely to fall too sharply despite an increasingly likely recession - especially at the short end of the yield curve, which primarily reflects the prevailing monetary policy. The current level of interest rates is therefore likely to remain with us for a while.

The era of negative-yielding debt officially came to an end at the beginning of the year. TINA (“There is no alternative”), the abbrevi-ation for the longstanding relentless hunt for yield in the negative or low interest rate environment, has now been replaced by BOB (“Bring on bonds”). In our view, investors do not have to venture too far into the lower end of the risk spectrum for fixed-income as-sets to capture the now increasingly attractive yields. The yields on short-dated corporate bonds with high credit ratings adequately compensate for recession risks.

Equities – Where are the earnings expectations going?

In a recessionary environment, companies are likely to lower their earnings forecasts further. In our view, global equity prices do not yet adequately reflect the impending recession and the associated potential for disappointment in corporate earnings. This will partic-ularly weigh on markets such as the US equities market, which re-mains relatively highly valued despite the losses in 2022.

We are keeping a close eye on developments in China. In particu-lar, consumer and travel activity around the “Chinese New Year” at the end of January should be revealing in this regard and also be supportive of the European markets, which are economically ex-posed to China.

Asset Allocation – A cautious start to the new year

In an environment of still alarmingly high inflation and further im-minent rate hikes, the market must prepare for continued difficult times and increased volatility. The short-term macroeconomic path – and thus also the development in financial markets – is now more broadly spread due to greater regional differences. On the one hand, US recession risks have increased. On the other hand, there is hope for an acceleration of growth in China. We therefore start the new investment year as we ended the previous one: with an underweight in equities, a neutral positioning in bonds and an overweight in alternative investments (incl. gold), as well as high liquidity in the portfolios.

However, not everything should be viewed too negatively with re-gard to 2023. In the past, equities began to stabilize as soon as inflation eased and central banks stopped raising rates. As soon as it is clear that the economy is in recession and the outlook brightens, this more optimistic scenario will also be reflected in ris-ing stock prices. Until that happens, we continue to favor defensive sectors and companies with strong pricing power within our equity allocation, which can defend their margins even in an environment of high inflation rates. We also like dividend stocks that generate stable and consistent earnings growth. Due to the developments in China, we have increased our positioning in emerging markets equities to neutral. The outlook for the region has changed for the better due to China's departure from its zero-COVID policy, justify-ing a neutral positioning.

Given the massive revaluation in the bond space over the past quarters, high-quality bonds with short maturities offer an attrac-tive risk-return profile. Therefore, we have gradually increased our bond allocation to a neutral level. Heading into a global recession, it seems premature to increase our allocation in high yield or emerging market bonds, despite a fairly high risk premium. We re-main underweight. These asset classes should deliver positive re-turns in 2023, but could come under temporary pressure due to recession risks. To take advantage of such opportunities during the year, we maintain our overweight in liquid and safe money market assets.