Making the most of the new economic era

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Key points:

Uncertainty may feel never-ending, but there are compelling reasons to be optimistic in the new economic era
Attractive yields present opportunities for fixed income investors, provided their bond allocations are working hard enough to find them
A world of higher nominal growth can also create a constructive environment for equities, especially if investors can diversify the opportunity set across regions and sectors

In an environment dominated by geopolitical instability and macroeconomic fragility, one of the greatest challenges for investors is how to separate noise from signal. This environment can foster a sense of never-ending uncertainty, challenging decision making and leading to inertia in portfolio allocations. However, while investors have to prepare for what can go wrong, they should also prepare for what can go right. Amidst this uncertainty, we believe there are compelling reasons to be optimistic about the opportunity set available to investors. By focusing on structural trends and considering a wide range of views, investors can position portfolios for positive long-term returns while also managing the complexities of the current economic era and the market volatility that comes with it.

The case for optimism

Despite the prevailing market narrative around uncertainty — which we don’t disagree with — there are important factors that justify a more optimistic approach.

While inflation remains above target, the volatility in month-on-month readings has fallen against a backdrop of slowing but still healthy global growth (Figure 1). A new regime of relatively robust nominal growth, with higher but fairly stable inflation, is taking shape, which we believe should prompt a renewed look at asset allocation across a global opportunity set.
Central banks are navigating a new paradigm in the growth/inflation trade-off. This brings with it two key implications for investors: rates are likely less responsive to growth shocks and investors are likely to experience a more divergent regional backdrop. Tight credit spreads may pose a challenge, but higher starting yields create a favourable environment for fixed income investments, providing a compelling and complementary alternative to equities for total returns.
Underpinnings of a resilient growth backdrop, including a healthy consumer base, well-capitalised businesses, and low unemployment rates, signal a positive environment for equities. While valuations in some areas of the equity market are elevated, diversifying the opportunity set across regions, sectors and individual securities will be key. Investors can root themselves in the fundamentals by focusing on the cycle, earnings, and robust research at the security selection level.

Figure 1

How best to put these insights together in an investor portfolio will naturally depend on specific circumstances, but here are some broader considerations that we think are worth bearing in mind.

Get more from your bond allocation

After very challenging years, 2024 saw bonds deliver solid total returns, with investors increasingly confident that fixed income can continue to play a critical role in providing positive, diversified returns to a portfolio. However, the current environment presents a diverse set of opportunities for bond investors. Given tight credit spreads, dynamic approaches such as sector rotation or flexible strategies can capitalise on emerging opportunities. This means that volatility, rather than being a source of fear, can become a valuable tool in an investor's toolkit. The current environment, with its attractive yields, offers an opportunity for fixed income investors to achieve both income and diversification – provided their bond allocation is working hard enough.

Think differently about equities

A world where high nominal growth can be sustained presents a constructive environment for equities, even in the face of full valuations and market concentration challenges. By expanding the opportunity set beyond US large-cap stocks, investors can balance still supportive US corporate fundamentals with other promising equity stories. We believe a quality focus, targeting well-priced, global companies with good fundamentals and exposure to structural trends, may represent a sweet spot for growth and uncover underappreciated opportunities. Quality has also been shown to be a linked to a greater chance of outperformance in high-inflation regimes (Figure 2). Additionally, we have reason to believe that companies with high financial returns and the ability to sustain them through stewardship — such as robust governance or a commitment to balancing stakeholder interests —may have an edge when it comes to navigating macroeconomic volatility over the long term. Finally, we are of the opinion that listed infrastructure — with its built-in exposure to long-term trends and inherent inflation sensitivity — may offer compelling investment opportunities, especially given low relative valuations for US utilities.

Figure 2

Add balance with high yield

A higher nominal growth world also bodes well for select exposure to high-yield investments, which can provide equity-like returns with lower duration risk relative to core bonds and more downside protection than stocks. This asset class, sometimes overlooked, offers a blend of growth potential and risk mitigation. By incorporating high-yield investments into their portfolios, investors can aim to achieve a balanced approach that leverages the benefits of both equity and fixed income markets.

How to be cautiously optimistic in a new economic era

In conclusion, while uncertainty remains a defining feature of the current economic era, we believe there are ample reasons for investors to adopt a more optimistic outlook. By focusing on structural trends and market opportunities, investors can navigate the complexities of the market and position themselves for potential gains. Whether through core fixed income, equities, or high-yield credit, a balanced and diversified approach can help investors achieve their financial goals.

As we navigate this new economic era, it is crucial for investors to remain vigilant and proactive but also to embrace the opportunities presented by structural trends and market dynamics. Diversify your portfolio, stay informed, and be prepared to adapt to changing conditions. By doing so, we believe you can seek to turn uncertainty into opportunity and maximise exposure to the bright spots that can help you achieve long-term financial success.

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Experts

Marco Giordano

Investment Director

John Mullins

Solutions Director - EMEA

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