iShares 2023 Investment Directions

• Our highest conviction allocation remains fixed income. We still see tremendous value in short-dated Treasuries for income, but also see benefit in opportunistically adding to duration for ballast in the potential coming recession. Persistent inflation and falling real rates could benefit Treasury Inflation-Protected Securities (TIPS), and local currency emerging market (EM) debt also looks attractive.
• In U.S. equities we end our preference for value and instead shift to exposures with quality characteristics to lead in a slowing economy. We also introduce a framework for identifying growth at a reasonable price, a screen that favors global tech and global energy.
• Our tactical overweight to EM equities is fueled by China’s reopening, a weaker dollar, and the potential for looser monetary policy in the region, though in the long run we see demographic challenges to growth and geopolitical tensions as a headwind.
• Both volatility and correlations in traditional asset classes have risen. Alternative diversifiers can be instrumental in choppy markets characterized by high volatility and low visibility. We see tactical opportunities to help hedge, diversify and pursue outperformance in asset classes such as gold and private credit.

As one of the most rapid policy rate tightening campaigns in recent memory likely approaches its conclusion, signs of distress have become evident in weak and poorly run areas of the global financial sector. While we strongly believe there is enough systemic liquidity in the U.S. and European banking systems, and that banks are adequately funded and capitalized, in markets fear can trump fact. A crisis of confidence can become a self-fulfilling prophecy if it spreads widely enough and persists for long enough.

Policymakers will closely monitor incoming data to determine just how much the banking shock will adversely impact financial conditions via tighter lending standards, wider credit spreads and greater caution in hiring, consumption, and capital expenditures. Fed Chair Powell made it clear that he views the resulting tighter credit conditions as equivalent to additional policy tightening, meaning the bar for further rate hikes has been raised.

For investors, we believe it is less important to quantify the precise impact of the shock on financial conditions than it is to understand the broad implications. While the Fed’s Survey of Economic Projections showed little change in the committee’s average expectation for the path of policy rates, they showed a material deterioration in GDP growth, down to 0.4% in 2023.¹ Combined with the Atlanta Fed’s GDPNow forecast of 3.2% for the first quarter of 2023, this implies a sharp slowdown for the remainder of this year.²

Slower growth and tighter financial conditions could mean a lower terminal rate and bring forward the timing of the first rate cut. While we still expect rates to be higher for longer on persistent inflation, we believe rates will probably be slightly ‘less high’ for slightly ‘less long’ than previously thought. That belief shapes our outlook for Q2 2023.

1. Our highest conviction allocation remains fixed income. We still see tremendous value in short-dated Treasuries for income, but also see benefit in opportunistically adding to duration for ballast in the potential coming recession. Persistent inflation and falling real rates could benefit Treasury Inflation-Protected Securities (TIPS), and local currency emerging market (EM) debt also looks attractive.
2. In U.S. equities we end our preference for value and instead shift to exposures with quality characteristics to lead in a slowing economy. We also introduce a framework for identifying growth at a reasonable price, a screen that favors global tech and global energy.
3. Our tactical overweight to EM equities is fueled by China’s reopening, a weaker dollar, and the potential for looser monetary policy in the region, though in the long run we see demographic challenges to growth and geopolitical tensions as a headwind.
4. Both volatility and correlations in traditional asset classes have risen. Alternative diversifiers can be instrumental in choppy markets characterized by high volatility and low visibility. We see tactical opportunities to help hedge, diversify and pursue outperformance in asset classes such as gold and private credit.