The “2023 Midyear Investment Outlook” by Morgan Stanley provides insights for investors to consider in the second half of 2023. The global economy is anticipated to experience a slowdown accompanied by increasing divergence, largely driven by persistent inflation and the tight monetary policies implemented by central banks. This challenging environment requires investors to make thoughtful decisions in order to generate returns surpassing the risk-free rate of return, which currently stands at the Federal Reserve’s policy rate of 5.2%.
To navigate this landscape, the report suggests that investors should focus on specific opportunities based on different regions. Asia is expected to exhibit stronger growth, lower inflation, and more accommodative policy measures compared to the United States and Europe. Therefore, investors are encouraged to adopt a more offensive stance in Asian markets while taking a defensive approach in the U.S. and Europe.
While cautioning about the risks associated with equities and high-yield bonds in developing markets, the report also highlights potential underappreciated opportunities. One such opportunity lies in agency mortgage-backed securities, which presently offer attractive total returns while being less risky than during the 2008 financial crisis due to more conservative lending standards. Valuations of these securities are similar to levels seen in 2008, and with expectations of declining U.S. government bond yields, they are deemed potentially irresistible.
Additional takeaways from the midyear investment outlook include the projection that U.S. and European equities may lag, with company earnings likely to fall short of expectations in the latter half of the year. In contrast, Japanese and emerging market equities are deemed attractive due to stronger growth, lower inflation, and accommodative policies, alongside reasonable valuations that could potentially yield double-digit returns over the next 12 months.
Regarding sector-level investments, defensive stocks such as consumer staples are favored in the U.S., while technology stocks in Japan, emerging markets, and Europe are expected to show upside potential. Healthcare investments are recommended across all regions.
In the realm of bonds, long-duration government bonds in the U.S., U.K., and Germany are anticipated to perform well, presenting attractive real yields despite high inflation and poor carry. Additionally, investment-grade bonds could serve as defensive assets, potentially offering positive returns amid soft economic growth in developed markets.
The report suggests that the U.S. dollar will likely remain strong, as it historically exhibits a negative correlation with equities, making it an appealing option for investors seeking defensive qualities. Furthermore, the U.S. dollar provides positive carry, enabling investors to earn additional returns by holding the currency or dollar-denominated assets.
In the commodities market, a return to more normal conditions is expected following a breakout year in 2022. Slower economic growth typically leads to reduced demand for base materials and energy, resulting in a forecast of flat prices for most commodities in 2023.
