German asset manager DWS, previously part of Deutsche Bank, discusses the macroeconomic outlook, and assesses portfolio allocations in 2023, focusing on equities, fixed income and alternatives.  

German asset manager DWS expects robust growth in emerging markets in 2023 and 2024, and the slowdown in the US and the eurozone to continue.

Growth in emerging markets is predicted to reach 3.9 per cent in 2023 and 4 per cent in 2024, the firm said in a note. As for the US, it rates the probability of a mild recession at 60 per cent, with a decline in growth to 0.4 per cent in 2024 from 2 per cent this year. In the eurozone, growth should continue to be slow, reaching 0.8 per cent in 2023 and 0.9 per cent in 2024.

The asset manager also thinks inflation will drop, reaching 4.1 per cent in the US in 2023 and 2.6 per cent in 2024. Inflation in the eurozone has already fallen to 4.3 per cent in September from 5.2 per cent, and DWS expects a fall to 2.5 per cent in 2024. Therefore, the firm expects that the interest rate hiking cycle to tackle inflation could be over in both the US and eurozone.   

Björn Jesch (pictured), global chief investment officer at DWS, highlighted that price gains of equities and bonds accumulated since the start of this year have partly melted away. He believes that the price potential for global equity markets appears to be limited for now. “In order to pave the way for a short-term recovery, 10-year treasury yields would have to stabilise or, even better, fall substantially,” he said this week.  Among equities, Jesch favours the communications sector, offering growth at an appropriate valuation, and consumer discretionary.

Equities
The firm sees little upside potential for US equities but forecasts a positive return outlook over a 12-month horizon for European equities. It expects neither a recession nor a dynamic recovery, but DWS believes that Europe should navigate through the next few months without major difficulties. Total returns are expected to be in the medium to high one-digit range by September 2024.

Equities from Asian emerging markets have also been disappointing this year and there are no signs of a positive shift yet, the asset manager continued. Tensions between the US and China are still around as are problems on the Chinese real estate market.  

Positive outlook for Japanese equities
Nevertheless, Lilian Haag, portfolio manager of global equities at DWS, believes that the outlook for Japanese markets is more positive. In the last couple of weeks, equity investors have had hardly any reason to rejoice – the price gains achieved since the start of this year have partly melted away. Japanese equities have not been spared. “However, in contrast with many other markets, we are currently constructive on Japan,” Haag said this week.

The price losses of the last few weeks might offer good entry points. “On the corporate side, we experience that the weak yen strongly supports export-driven Japanese companies,” she added. The return of tourists, who had kept away for a long time, is another driver of the domestic economy. A positive aspect is also the return of inflation, with its favourable impact on the growth of the nominal gross domestic product as well as of corporate profits. “We have not seen such a situation in twenty years,” she continued.

The asset manager highlighted how economic dynamism is not currently threatened by headwinds from the Japanese central bank. With an inflation rate now on a level of 3.5 to 4 per cent, no rate hikes or other restrictive measures are to be expected from the Japanese central bank.

In addition to these positive effects, there is also the China factor, the firm added. For Asian investors, investments in Japan are increasingly an alternative to investments in China. A gradual recovery of China and the global economy should also have a positive impact. And, finally, international investors are still underinvested in Japan, Haag said. Her views have been echoed by other asset managers who also see the promise of Japanese equities. Andy McCagg at Nomura Asset Management believes that there are a lot of investment opportunities out there. See more here. 

Investment-grade corporate bonds promising   
DWS said the last few weeks have been bleak, on both fixed-income markets and on equity markets. Rising yields have caused a marked melt-down of the positive total returns accumulated since the start of this year. “We are currently neutral on 10-year sovereign bonds, except for US bonds. Investment-grade corporate bonds should offer better chances. Still high corporate profit margins and a comparably low leverage are good basic conditions,” Thomas Höfer, head of investment grade credit EMEA, said.

Due to the recent increase in volatility, the yield spreads of investment-grade Euro corporate bonds versus Bunds have increased to 160 basis points (100 basis points are equivalent to one percentage point).

“This should be an interesting entry level,” Höfer continued. By the end of 2024, he expects yield spreads to narrow to 110 basis points. Chances of price gains are, therefore, correspondingly good, he said. He is not alone in his positive stance on fixed income. With the rate-hike cycle close to ending, Alain Krief, head of fixed income at Paris-based Edmond de Rothschild Asset Management said at a media conference this week that fixed income markets offer excellent prospects. "It’s a must in a diversified portfolio," Krief said. However, given the threats to growth, he believes that it is vital to avoid default risk by moving the quality bar higher in both the investment grade and high yield segments.

Alexander Eventon, fund manager corporate hybrid bonds at Edmond de Rothschild AM said they are focusing on the shorter end of the yield curve as long bond yields – maturities over 10 years – could increase further to reflect rising term premiums. He recommends carry strategies on high-quality credit while preferring short maturities. In investment grade, he prefers low duration and both financial and corporate subordinated bonds. In today's environment, fixed maturity bonds look particularly interesting, he added.

Together with other investment managers, Stephen Dover, chief market strategist at the Franklin Templeton Institute, also thinks that fixed income deserves more love. The highest quality areas of the credit market have become more attractive, providing higher yields in investment-grade bonds relative to the dividends from equities, Dover said. See more here. 

Looking at alternative assets, DWS is more constructive on gold, expecting the headwinds from interest rates and the dollar to wane. The firm also believes that gold should remain in high demand.