Winter chill: where to invest in a recession

Key takeaways

Geopolitical tensions, an energy crisis and inflation have marked global activity in 2022. The ball is now in the court of central banks, which in the months ahead will have to quell runaway inflation without risking a global economic freeze.

As we enter the last quarter of the year with recession looming in many markets, our Vontobel investment experts look at the challenges ahead and pick opportunities.

Christel Rendu de Lint, Deputy Head of Investments, Vontobel: What is on the cards from the US Federal Reserve until the end of 2022 and in early 2023?

Ramiz Chelat, Portfolio Manager, Quality Growth Boutique, Vontobel: We think inflation will remain high and will take time to come down. So 4%-4.2% rate expectations by year end are reasonable. We think it's too early to make a case for rate cuts by the middle of next year, and it will very much depend on how quickly inflation can come back closer towards that 2%-2.5% target.

Christel Rendu de Lint: Do you think a recession is now unavoidable? How will that impact your investment view?

Ramiz Chelat: We want to make sure the portfolio can handle weaker growth. We have increased our positioning in more defensive growth names in healthcare and consumer staples. We've also made sure the portfolio can manage inflationary pressures well. The key names we own have displayed good pricing power, the ability to manage inflationary pressures and no exposure to trading down risk, which is also a concern.

Christel Rendu de Lint: I'd like to turn to emerging markets. Thomas, would you say discussions about risk have changed?

Thomas Schaffner, Portfolio Manager, Vontobel: Risks in emerging markets have been going up since the election of Donald Trump. But we also have a high-risk premium. So, investors get rewarded or compensated for running the risks of investing in emerging markets.

We are actually seeing some improvement at country level. For example, China’s monetary policy has become easier and regulatory pressure has started to ease since the beginning of the year.

Christel Rendu de Lint: Wouter, how do you see those risks in the fixed income space?

Wouter van Overfelt, Head of Emerging Market Corporates, Senior Portfolio Manager, Vontobel: Risks have gone up recently with the inflation risk. Of course, a stronger dollar is not good news generally for emerging markets. I would also agree with Thomas that investors are currently compensated for the risk they are taking. We have seen a long streak of negative returns and I think valuations are now quite attractive.

On the emerging markets corporate side, I think duration is a little bit lower than other fixed income asset classes because people are more concerned about default risk. And then, there’s the geopolitical risk. But I think political and geopolitical risk are always a part of investing in emerging markets.

Christel Rendu de Lint: We can't talk about emerging markets without discussing China. How do you see the outlook for the Chinese economy and equity market?

Thomas Schaffner: China started tightening both on the regulatory and monetary side in 2021, so it’s well advanced into the cycle. It has now taken a few steps to ease both regulatory and monetary policies. However, these measures only have a limited impact because of Covid. Once Covid is brought under control, then all these measures will have an impact. This should help boost the economy in China, but also the stock market.

Christel Rendu de Lint: Ramiz, do you share this view?

Ramiz Chelat: We remain relatively cautious on China. We're not expecting a sharp rebound in economic growth. If you look at key areas of the Chinese economy, such as the property sector, property sales in the top 20 cities are down around 40% year to date. Over the last two months, there has been news of mortgage boycotts as buyers have less confidence in developers completing projects. We think the government will need to introduce a more aggressive stimulus to boost the property sector.

Infrastructure remains one bright spot, but we don't think that's enough to offset the weakness in property and consumer. We find attractive investment opportunities in areas that have low regulatory risk, such as consumer staples with good pricing power.

Christel Rendu de Lint: I'd like to turn now to opportunities in emerging economies. Wouter, where do you see them in fixed income markets?

Wouter van Overfelt: Valuations have already adjusted. With the political risks that we're seeing – but also the conflict between Russia and Ukraine – unexpected things do happen. Therefore diversification is very important in any portfolio.

One of my preferred regions is China. Valuations have adjusted to levels beyond what can be reasonably expected from a fundamental point of view. So, we do expect recovery there. And then, of course, commodity-related companies should also offer attractive opportunities for investors.

Christel Rendu de Lint: What about the equity perspective, Thomas?

Thomas Schaffner: There are long-term structural themes like energy transition, for example, and quite a few companies in Asia and China are providing the hardware. A lot of these names have sold off now, so we start to see opportunities there.

Christel Rendu de Lint: We've seen an increase in the share of passive vehicles in our industry. With all those opportunities, can investors go passive?

Wouter van Overfelt: They can, but I wouldn't recommend it. I do think there is a lot of confusion on the passive side. First, people look at benchmarks, maybe exchange traded funds, but generally ETFs that are underperforming the benchmark – at least in the corporate space. Secondly, I think it's important to build a portfolio consistent with their targets, and therefore with the investment process that they have in mind.

I don’t think closing your eyes and buying everything is an optimal solution in the face of volatility.

Christel Rendu de Lint: What’s the situation with emerging markets?

Wouter van Overfelt: There are various things at play on the emerging markets corporate side. Some companies have had margin pressures. There is a refinancing risk on top of that. I think valuations have largely adjusted, but we should be mindful there.

We should not forget that within the emerging corporate space you have a lot of quasi-sovereign issuers, which probably get state support or are in the commodity sector. That should also provide some safety from these issues.

Thomas Schaffner: While emerging markets still get a relatively cheap supply of oil compared to companies in Germany, there might be an opportunity because companies in emerging markets – China and India in particular – are becoming more competitive compared with companies in Europe.

Christel Rendu de Lint: Ramiz, what’s your perspective?

Ramiz Chelat: We think margin pressures have peaked in the first half. If we look at staple companies, key inputs such as palm oil have come off quite sharply. And for the industrial companies, commodities such as copper and aluminum have also come off quite significantly. Supply chain issues are easing in areas such as semiconductors.

We think some of these companies will see a positive tailwind in the second half and into 2023. Many of the companies have taken pricing over the last six months, which should help margins in 2023. So, we think that margin risk going forward has certainly decreased.

Christel Rendu de Lint: Thank you very much for your insights. I'm looking forward to speaking with you again soon.