T. Rowe Price released its outlook for global financial markets for the balance of 2023 and the message is reluctantly bearish for the short term, with more room for optimism over the longer term.
Contributing factors making the near term uncertain include stubborn inflation, despite some recent slowing, tightening financial conditions and higher interest rates, a risk of recessions in many developed markets and reduced lending after the failure of several U.S. regional banks.
The resilience of many world economies is being tested as the effects of a steep U.S. Federal Reserve interest rate hiking cycle and a shift from quantitative easing to quantitative tightening are still being felt.
Labor markets remain strong and are an important signal for investors to watch as any softening could increase the risk of a recession.
As always, company earnings are an important focus. Although equity markets have delivered gains in the first half of 2023, earnings estimates may be too high for a weakening economy, putting further pressure on equity valuations.
Bonds, which suffered badly in 2022 alongside stocks, present potentially attractive opportunities in high yield, bank loans, and sovereign and local currency debt in certain emerging markets.
“The market is trying to reconcile two very different scenarios – one where the U.S. economy remains fairly strong and the Fed doesn’t cut rates, and one where the Fed has to cut by several percentage points. In Europe, I expect both the European Central Bank and the Bank of England to raise rates despite the associated economic risks. The Fed and other central banks in developed markets will lower rates eventually, but the timing is tricky. Rates are likely to remain higher for longer. Some emerging markets may be on the verge of rate cuts, but they are only attractive on a very selective basis,” said Arif Husain, Head of International Fixed Income and Chief Investment Officer.
In addition, Sébastien Page, Head of Global Multi-Asset and Chief Investment Officer commented: “Whenever the Fed has slammed on the brakes, someone’s head has gone through the windshield. This time it was some U.S. regional banks. Stock valuations aren’t broadly attractive right now, but small- and mid-cap stocks are trading at significant discounts to their historical averages, with small-caps priced like it’s 2008. In an uncertain environment, market dislocations are inevitable. With both stocks and bonds, skilled active management can help navigate market volatility by taking advantage of opportunities and avoiding riskier exposures. My takeaway fits in a fortune cookie: stay invested, stay diversified.”
