“Higher for longer” rates: what impact will they have on various asset classes?

Government bonds yields rising Bund at the highest since 2011

(Finance) – “The market will have to deal with high rates for a while longer. As a result, investors are presented with different allocation options compared to the limited equity alternativesor which have dominated in recent times. Indeed, stock markets will continue to face greater volatility due to the new higher rate environment. This creates new opportunities and highlights the importance of building your portfolio according to tactical asset allocation strategies.”

Thus begins the analysis of Michael Lok, Group CIO and Co-CEO Asset Management of UBP who explains: “Based on our macroeconomic scenario for 2024, we believe that fixed income offers attractive returns, as it should finally have reached the end of the two-year bear market: rates have reached peak and the Federal Reserve is likely to start cutting them in the second half of next year.”

Within the bond universe – observes Lok – “we prefer investment grade bonds with an intermediate duration (3-5 years) or short-term high yield bonds (1-3 years). We are not investing in bonds with a longer duration, as 10-year yields have limited downside in a solid macroeconomic environment, while the US deficit will remain a long-term concern for investors.

Despite the high volatility, we maintain a neutral allocation towards equities, which remains one of the few asset classes capable of offering unlimited returns. After two years of limited growth, we believe 2024 will see double-digit earnings. Thanks to a strong macroeconomic environment and persistent inflation, US companies will see revenue growth accelerate. With global stocks currently trading below their historical valuation averages, any excess downside will give investors the opportunity to increase their exposure.”

Given the greater volatility – he continues – investors should favor the use of equity-linked structured products capable of achieving similar returns even with lower volatility. We maintain a neutral exposure to hedge funds and gold, as these asset classes have proven to be a valuable source of diversification within portfolios in the past, particularly in times when both bond and equity markets were both decreasing. As regards equities, we maintain a neutral position, supported by the solidity of the US economy and the peak in interest rates, which benefit from the reduction in inflationary pressures globally.

However, we do not expect stock valuations will improve from their current levels, as alternatives have already emerged offering similar returns but with lower volatility.

For the stock market, we expect that in 2024 there will be an expected total return of 12%, of which 10% will come from corporate earnings growth and 2% will come from dividends/share buybacks. We remain overweight US equities and have upgraded our exposure to Japan (from underweight to overweight) as economic and governance reforms are expected to trigger an acceleration in earnings growth,” Lok further notes.

“As for the central banks, both the Fed and the ECB are expected to continue with a pause, while the risk of further increases is limited. Therefore, we maintain a neutral stance on the duration of exposure to all currencies, while waiting for the yield curve to normalize further We continue to favor high quality bonds as market technicals remain solid, with high yields, moderate supply and spreads that should remain range-bound. The 3-5 year part of the curve seems the most interesting to lock in yields and benefit from a strong roll-down.”

“Credit spreadsor they are only in the mid-range and the credit metrics of high-yield companies are deteriorating as they get closer to the refinance date. It is too early to add risk and we prefer to remain selective in the high-yield segment, focusing on short-duration issues.

Towards the end of the year, US dollar exchange rates will remain well supported, thanks to high levels of front-end carry and continued positive momentum in economic data. The euro/dollar exchange rate should settle at lower levels, in line with the trend of two-year interest rate differentials; a move to 1.02 is possible“, concludes Lok.