Opportunities on the Horizon: Investing Through a Slowing Economy

overview | WEALTH OUTLOOK 2023 | MID-YEAR EDITION | 8 But as the yield curve inverted, investors have started to refocus their attention to technology companies with strong balance sheets and growth prospects. Even though US industries have powerful and promising growth prospects, 2023’s tech gains have been limited to a handful of companies. Large Cap US IT is up 37% year to-date. 8 Firms providing the infrastructure for a new form of artificial intelligence, known as generative AI (See Generative AI: The beginning of (another) technological revolution ) are responsible for a lot of that gain. And while we will add further exposure to generative AI, many other future portfolio opportunities may lie in small- and medium-sized tech companies whose valuations do not yet reflect their future growth potential. Alternative investing and private credit Finally, we see an opportunity within alternative investments for qualified investors. A shortage of capital now exists in private credit. Banks have pulled back their lending due to deposit woes and an overexposure to commercial real estate assets, like office space. The Fed is continuing quantitative tightening, while the Treasury is ramping up borrowing and investors are hoarding cash and short-term investments. For qualified investors, it may be possible to earn equity-like rates of return in selected debt securities. 8 S&P 500 Information Technology Index. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary. 9 Private equity firms lend less as demand cools, March 3, 2023 by Chibuike Oguh. 10 Source: Global Financial Data as of June 5, 2023. Loans for private equity buy-outs, lending to later stage venture companies, mezzanine debt for real estate refinancings and other similar lending opportunities are yielding more than 10% per annum. 9 Unlike in 2008-09, we do not see a credit collapse on the horizon. Corporate balance sheets are in good shape with future credit problems likely to be concentrated in commercial real estate. Capital shortages do not occur frequently, so this is an area where qualified private investors may benefit for the next three to five years. Watch for signals The double-digit declines in both stocks and bonds in 2022— the worst combined return for 60/40 portfolios since 1931 10 — reset valuations and the relative value of different portfolio investments. In anticipation of poor market conditions in 2022, we doubled up on defensive investments in 2021. Though we prefer the long-term return properties of dividend growth shares, we expect to return to a normal weighting. And while we currently enjoy a high yield on short-term high-grade bonds, we will rotate from them to intermediate US and emerging market credit to continue to seek income and potentially benefit if and when rates fall. We will move from defensive to overweight risk assets as a result of valuation improvements and market dislocations as they arise. The US Treasury hit its debt ceiling at the start of 2023 and took emergency steps to limit debt issuance. Now, we expect $1.3 trillion in new borrowings, likely by the end of the third quarter of 2023. When the Treasury needs to raise a huge amount of capital and the Fed continues to tighten, we anticipate that fears about more Fed policy tightening will lower prices of already attractive assets. Looking ahead One of the reasons we are seeking to diversify equity exposures from the S&P 500 is that large- cap stocks have performed above expectations over the past two years yet actual S&P 500 earnings per share has declined in 2023. This means we see them as expensive on a relative basis. While they may rise in value in 2024, US large cap shares are less likely to lead the market higher. To capture the potential of our new Strategic Return Estimates, 1 we will consider rotating toward different risk assets, geographies and strategies in the second half of 2023 and into 2024. We may diversify our equity selections and “go overweight” across equity strategies as potential opportunities become apparent. We expect US bonds to act as a foundation for portfolios, seeking positive real yields and negative correlation to reduce portfolio volatility. Here we will seek diversification to non-US