By Dinah Wisenberg Brin, ThinkAdvisor

Northern Trust Asset Management expects ongoing but tempered volatility in 2023 as worries over inflation and interest-rate hikes give way to lower inflation, a pause in rate increases and a weak global economy.

“While we believe there is downside risk from fundamentals, we see upside potential from likely improved investor sentiment,” Northern Trust Chief Investment Officer Angelo Manioudakis said in a statement recently.

“Financial markets will have to balance the immediacy of disappointing global growth against the backdrop of greater certainty on central bank policy, a reduction in interest-rate volatility and the potential of a return to growth later in the year.”

The firm, which has $1.2 trillion in assets under management, built its 2023 outlook on themes from its five-year capital markets view, which include slower growth, inflation recalibration and monetary drought, i.e., less monetary support, in coming years.

The firm said it is balancing downside risks with the potential for an improving investment outlook as 2023 progresses.

Here’s a look at the firm’s economic and market predictions for 2023, which it forecasts to be “a pivotal year.”

1. Corporate profit pressure

Northern Trust says it sees downside risk to corporate profits, “consistent with an economic slowdown or recession.” However, pockets of economic durability should limit a U.S. earnings downturn, the firm says.

While equity valuations should be less of a headwind in 2023, Chris Shipley, Northern Trust chief investment strategist for North America, noted, the year should be volatile for equities globally as economic growth and corporate profits disappoint but sentiment improves.

Northern Trust is neutral weight developed-market equities and, given China’s struggles, underweight emerging-market stocks.

2. Better sentiment?

Investor sentiment should improve, Shipley said, as inflation slows and central banks pause their rate hike campaigns in 2023. Sentiment has runway to improve from beaten-down levels, especially in Europe, according to the firm.

3. Developed market outperformance

Developed markets should perform better than emerging markets, where “intermediate-term challenges outweigh a bumpy and uneven reopening of China,” Shipley said. Northern Trust says it prefers to play China’s reopening through developed-market stocks, where there’s greater clarity.

4. Central banks pause

The Federal Reserve next year will hike its benchmark interest rate by 0.50% to 0.75%, reaching a steady policy rate of 5%, “likely sufficiently high for a Fed pause,” Northern Trust predicts.

Interest rates outside the U.S. should hold steady or decline on reduced inflation risk and higher recession risk than in the U.S., the firm says. The firm expects Treasury yields to rise slightly “but remain stable thereafter as we think labor market strength will make the Fed hesitant to reverse course.”

5. Global economic slowdown

Central banks’ steep interest rate hikes this year are a firm headwind to growth, with the consequences not fully realized yet, according to the firm.

Northern Trust expects Europe to slip into recession, given its greater vulnerability to elevated energy prices, for the U.S. economy to slow meaningfully, and for emerging markets to remain pressured by China’s struggles.

6. Bond market opportunities

Investors are likely to find more opportunities in the bond market, with higher income and continued corporate resiliency in 2023, according to the firm.

High-yield bonds are Northern Trust’s biggest tactical overweight heading into the new year, supported by stable fundamentals, low default rates and historically high credit quality, the firm says.

Investment-grade bonds are its largest underweight, despite an expectation that returns will turn positive in 2023. The firm expects investment grade to receive a boost from a resilient consumer and more muted interest rate volatility.

The firm is equal weight inflation-linked bonds “on the basis that central banks have the tools and perceived willingness to contain inflation, but that this is mostly reflected in valuations and the path back toward target levels may prove difficult.”

7. Real assets benefit

Real assets, notably natural resources and listed infrastructure, provided stability to diversified portfolios this year, showing that higher inflation, especially in commodities, can benefit these asset classes, Northern Trust says.

The firm is overweight natural resources, which should benefit from persistent cash flows, tight commodity markets and attractive valuations next year. These assets can provide a hedge against inflation and potentially give a boost if China re-opens successfully.

If interest rates stabilize or fall for an extended period, global real estate should post solid gains, according to the firm, which is equal weight global real estate and infrastructure.


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