Drawing on the insights of 32 market strategists, portfolio managers, research analysts and economists at Natixis Investment Managers and 13 of its affiliated investment managers, as well as Natixis Corporate and Investment Banking, the survey reveals that 50% rate recession as a low risk in H2, but that said, they remain cautious, warning that market headwinds are intensifying with an uncertain picture for H2 emerging.

Nearly three quarters (72%) are concerned that inflation may linger longer than expected and 38% think rates could stay high for longer than anticipated, as 66% also worry about corporate earnings, finds the mid-year survey.

Surprising start to the year

The first half of 2023 surprised strategists and investors. In November 2022, 59% of institutional investors believed recession in 2023 was “inevitable” and 54% said recession was “absolutely necessary” to curb inflation*. The reality is a different picture as markets delivered solid returns, bonds generated attractive yields, and inflation began to ease around the world, dropping to 3% in the US.

The survey reveals that over the rest of 2023 just 6% of strategists believe a recession is “inevitable”, 53% say there is a “distinct possibility”, and 9% think recession is “highly unlikely”.

Inflation: from high anxiety to easing prices

After a painful run of increasing costs, central bank efforts to ease the pressure began to produce results in H1. In the US, inflation shrank from 6.5% in June 2022 to 3% by the end of H1 2023, while in the Eurozone it fell from 9.2% to 5.5%. The UK has failed to keep pace, but is starting to show signs of inflation easing, falling from 10.5% at year-end to 8.7% in May.

Only 22% of strategists surveyed say inflation is a “high risk” in the second half of the year, however, 38% of strategists do not believe inflation targets will be met until 2025, and 9% say they may not be met until at least 2026.

Investors shouldn’t be complacent as headwinds remain

Geopolitics (72%) and central bank policy (72%) draw the strongest consensus when it comes to headwinds. However, a quarter (25%) of strategists do not think geopolitics will impact markets in the second half of the year, instead calling geopolitical issues “noise”. Bank policy concerns centre around the question of how high and for how long rates will remain restrictive before inflation is back to target levels.

Corporate earnings are a potential headwind for 66%, however 25% are optimistic and say earnings may act as a catalyst in the second half of the year. Strategists are also split on the outlook for consumer spending as half worry a slowdown in spending will serve as a headwind, while 28% believe consumer spending will increase providing a catalyst for market growth.

“Inflation is cooling off, but we aren’t through the woods yet. Strong consumer spending, inflated cost of services, and geopolitical tensions may keep inflation lingering for longer which will result in higher rates for some time yet. Strategists generally think it will take until 2025 until targets are met,” said Mabrouk Chetouane, Head of Global Market Strategy, Solutions, Natixis IM.

Finding opportunities

When considering the headwinds and opportunities, 34% of the market strategists say the US is best positioned for the rest of the year, and 22% think either Japan or emerging markets (excluding China) will be the winner. Just 16% think Europe will be the leading market, while only 6% believe it will be China. None of the strategists are backing the UK. There is strong consensus that large caps (81%) will outperform small caps (19%), in part due to tighter credit standards set in the wake of Q1’s banking crisis.

Strategists are torn between whether growth or value will outperform to year end, seeing a 50/50 split.

Bond markets

After 15 years of low and negative yields, yield returned in 2023. As central banks hiked rates to the highest levels since the global financial crisis, investors took advantage. Yields on 10-year Treasuries reached 3.84% in June as 10-year Eurozone Central Bonds reached 3.21%. Asked for their outlook on H2:

• 47% think US Treasury yields will come in at 3.5%-4%
• 41% see rates receding, leading 28% expecting 10-year Treasuries to drop to the 3%-3.5% range
• 13% think rates could move to between 2.5%-3%.

However, there are still concerns for fixed income investors:

• 72% worry inflation may linger longer than expected
• 38% think rates could go higher than anticipated, 38% also believe they could stay high for longer than expected, and 38% are worried about corporate defaults and downgrades
• largely strategists are not worried about consumer credit and the housing market as only 13% say they are concerned, but 69% see central bank mistakes as a risk (53% medium risk and 16% high risk).

With all things considered, 56% of those surveyed think long-duration bonds will outperform short-duration bonds by the end of 2023.

Equity rally likely to cool

Markets rallied in the first half of the year, largely due to the re-emergence of tech. The NASDAQ delivered returns of 30% – the best H1 in the index’s 52-year history. The tech rally, driven by excitement around artificial intelligence (AI), also helped the S&P 500 gain 15.91%. In Japan, corporate reforms and a focus on sustainable growth saw the Nikkei to see returns of 27.91% by June 30 – the biggest gain in 33 years.

However, none expect the tech rally to intensify, less than a third (31%) expect it to “continue steadily” and 6% of strategists think the “bubble will burst”, so expectations should remain realistic. Half  think equities more generally will cool off in H2 and prices will dip to reflect the fundamentals.

When asked specifically about AI, while 88% believe it can unlock previously undetectable investment opportunities and 69% believe it will accelerate day trading, 100% of the strategists surveyed believe it will increase potentially fraudulent behaviour.

“Compared to expectations at the end of 2022, 2023 has been surprisingly positive so far, but investors need to stay alert to ongoing headwinds to prevent complacency. Inflation has gone from an all-consuming concern to a manageable situation in most developed markets, but it could take some time before aggressive targets set by central banks are met.

“Big tech helped equities come roaring back in the first half of the year but, while few predict a major downturn, most are concerned about corporate earnings across H2 and expect the rally to fade away by the end of the year. Recession is still a real possibility, but most expect a softer landing. The successes of H1 may dissipate, but our strategists and economists still believe there are good opportunities if you look carefully,” said Mabrouk Chetouane.

Read the survey.

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Adam Abbas

After six months of navigating rising rates, inflation and geopolitical tensions, recession fears are on the rise for 2022, casting a long shadow over prospects for global economies and markets in the second half of the year.

Results of a mid-year survey of 34 market strategists, portfolio managers, research analysts and economists at Natixis Investment Managers and 15 of its affiliated investment managers, as well as Natixis Corporate and Investment Banking, show that nearly a quarter (24%) believe a recession is inevitable in the second half of 2022, while 64% believe it is a distinct possibility. Nine in ten believe central bank policy will be the biggest market driver over the next six months.

“Ten years of over-reliance on easy money led to significant outperformance for growth equities. That’s over for the foreseeable future. The biggest market driver at the end of 2022 will be central banks and bringing down inflation to lower the longer-term cost of capital,” said Katy Kaminski, Chief Research Strategist and Portfolio Manager, AlphaSimplex Group LLC.

Inflation tops market risks

Key market assumptions for low rates, low inflation, and low volatility may have boosted market performance for more than a decade, but since the start of the year that unique confluence of factors has been reset. The catalyst for much of this shift has been inflation.

In fact, seven in ten rank inflation as the biggest market risk for the second half of the year. Even though it has tapered slightly since its high, 36% of respondents go so far as to set the level of risk due to inflation as a 10 out of 10.

Central banks also factor into the picture with 52% citing their policy decisions as a key inflation driver. Another 46% also believe that the supply chain issues that helped drive inflation early in the pandemic will continue to do so through year-end. However, less than one in four believe inflation will remain persistently high.

Recession is a distinct possibility, if not inevitable

Faced with prospects for rising interest rates and tightening monetary policy, strategists place recession as a close second on the list of concerns with 64% ranking it as a top risk.

Policy makers have many tools at their disposal to address inflation and given the challenge of achieving the right timing for policy implementation, the margin for error is slim.

For many the question remains as to whether these efforts will thwart inflation, trigger a recession that could last two to three quarters, or result in stagflation that lasts for years. With all the possible outcomes, no wonder more than half (55%) of those surveyed also cite a central bank error as a key risk.

“The word recession is casting a long shadow over the markets, but in some ways the only way out of this inflationary environment is for central banks to trigger this recession. Then we’ll come out on the other side of the inflationary shock, and the markets could then rebound,” said Mabrouk Chetouane, Head of Global Market Strategy, Natixis Investment Managers Solutions.

Geopolitics, war, and oil

Inflation, recession and central bank policy may factor prominently in their views on market risks. Yet strategists also see the potential for world events, like the war in Ukraine, as key risk considerations as 65% of those surveyed place geopolitics as a top risk and as an offshoot, nearly half of those surveyed (47%) see energy prices as a significant risk for markets in H2.

To underscore the connection between politics and energy, oil prices spiked to $120 per barrel in at the outset of the war in March and has since moderated to $106 at the end of Q2.^[1] Looking ahead, nearly half of strategists (49%) anticipate West Texas Intermediate crude will end the year somewhere in the range of $100-$125. And while there is still 15% who believe prices will rise past the $125 mark, the larger number (33%) forecast that prices will drop between $85 -$100.

What a difference a year (or two) makes

Of all that strategists forecast for H2, the most telling sign of the times may be how their views on COVID-19 have changed. Where the pandemic had resulted in a worldwide lockdown in 2022 and continued work from home orders in 2021, even with the highly contagious BA variants spreading globally, few (9%) believe a COVID disruption will present a risk in the second half of the year.

Value continues to shine

One of the key trends to emerge out of pandemic-driven disruptions has been the outperformance of value stocks. Low rates and low volatility had provided a rising tide in which most stocks excelled over the past decade. As a result, it was harder to find underpriced stocks. Now, with rates on the rise and volatility back in earnest, value strategies have outperformed growth. Almost six in ten (58%) believe the run will be extended for at least a few more months, while one-quarter (24%) think value will be on top for a few more years. Less than one in five (19%) think the value trend has already run its course.

“The opportunity set is shifting rapidly. The new environment is creating idiosyncratic opportunities that are more attractive investments than the broader indices. These opportunities can be found across multiple sectors,” said Chris Wallis, CEO, CIO, and Senior Portfolio Manager, Vaughan Nelson Investment Management.

Bond markets

One of the biggest changes to the investment landscape over the first six months of 2022 has been the slow and steady increase in interest rates, with bond yields following in step. After closing out 2021 at 1.512, a series of rate hikes – including a surprise 75 basis point hike in June – put yields at 2.975 on June 30, 2022.

Underscoring just how closely they will be watching central bank policies in the second half, 73% of those surveyed believe there will be more increases: 36% believe US Treasuries will finish the year somewhere between 3% and 3.5%. The same number anticipate even more hikes and forecast rates reaching above 3.5% by year’s end.

“This year, the global bond markets suffered unprecedented losses, and few people would have ever thought of bonds as unprotected money. But there are signs that we’ve passed the high of inflationary pressures, and now is the time to find the opportunities out there, for instance in financials, energy and industrials,” said Adam Abbas, Portfolio Manager and Co-Head of Fixed Income, Harris Associates.

What it all means

As strategists view this new fixed-income landscape there is no clear consensus on what it means for investors. Rate hikes may continue to depress bond values according to 27%, creating attractive opportunities for those who know where and how to look. Those taking the cue from the 27% who say it’s time to start buying bonds again may want to consider the advice of the 24% who say that at times like this credit quality will matter more than duration.

The end of an era

Strategists see a world that has changed dramatically in the past six months. After a decade in which the easy money provided by quantitative easing, low rates, and low inflation propelled markets to positive gains in seven out of ten years, the world is moving on. This next normal is marked with greater volatility and greater uncertainty. The big question for most investors may well be how long will it last?

Read the full survey report.

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[1] Source: “Crude OIL” Crude Oil – 2022 Data – 1983-2021 Historical – 2023 Forecast – Price – Quote – Chart, Trading Economics, https://tradingeconomics.com/commodity/crude-oil

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