One of the largest players in global wealth management argues that while a recession is a certainty at a particular point, right now investors must concentrate on shielding portfolios from the ravages of inflation.
There will be a recession at some point but right now investors should do more to shield from high inflation, and position their portfolios accordingly, UBS says.
One of the world’s biggest wealth management houses – total invested assets of $3.145 trillion at end-March – said it thinks commodities are attractive and an effective way to hedge further inflation and geopolitical risks. It is also moving equity exposure towards value, energy, and more defensive sectors such as healthcare.
“We are 100 per cent certain there will be a recession someday in our future, but not yet. In our base case, it is not yet time to position for recession. Rather, we are focused on how investors can best capture opportunities at a time when inflation is high and fears about a central bank overreaction are driving markets,” Mark Haefele, chief investment officer at the global wealth arm of UBS, said in a monthly note from the Swiss bank.
Recent data continue to keep inflation top of mind. US consumer price inflation in March came in at 8.5 per cent from a year ago.
“The geopolitical and economic uncertainties I discussed in my last letter show no sign of abating. The Russia-Ukraine war continues, at great humanitarian cost and with signs of escalation, while China’s Covid-19 challenges persist. When investors are able to focus on something other than these concerns, attention shifts to inflation and a Federal Reserve-induced recession,” Haefele said.
For some time, policymakers and wealth managers wondered whether the rise in inflation was temporary, brought on by supply chain turmoil, the Russian invasion of Ukraine, or another force. It appears clear that the US Federal Reserve no longer thinks it is transient, he said.
“As we get further into the US earnings season, we are learning that profit margins remain healthy despite inflation. Consumer spending has been robust, new jobs are being created, and we believe growth will remain above trend despite the recent US GDP report,” Haefele said, referring to figures showing that US gross domestic product shrank in the first quarter of 2022.
“Positioning portfolios for recession means deciding that the Fed will fail to win a game in which it ultimately controls nearly all the cards and sets nearly all the rules. In other words, to steer the US economy into a recession is still an active choice that the Fed may make, but not one it wants to make. We, the Fed, and the market acknowledge that the room to manoeuvre and avoid recession has narrowed over time. Yet many investors we speak to should do more to position for inflation – a clear and present fact – than recession, which is still only a future possibility,” he said.
The bank thinks inflation is likely to fall but remain above pre-pandemic ranges. This will give the Fed more room to manoeuvre and allow the market to reduce its expectations for rate hikes.
“We expect growth in 2022 to be slower than last year, but not tip over into recession. In an environment of moderating growth and inflation, we expect broad equity markets to finish the year higher than current levels,” Haefele said.
“In an environment of lower expected returns and a high correlation between bonds and equities, investors should ensure portfolios are well diversified, with exposure to alternatives such as hedge funds and private markets. More active portfolio management is also important, and we tilt our positioning towards areas of the market that can perform well in an environment of high inflation, rising rates, and elevated volatility,” he continued.
In fixed income, Haefele said rising yields mean that areas of value are emerging. In March the least preferred stance for UBS was investment grade bonds, and now the bank makes the same shift for high grade bonds. “We remove our preference for US senior loans, which performed well during the sharp run-up in yields,” he said.