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Market Outlook
Think Future 2023 Mid-year Edition

Willem Sels

Global Chief Investment Officer, HSBC Global Private Banking and Wealth

Broadening opportunities amid a diverging growth outlook

As we look ahead to the final months of 2023, the financial markets are at a critical juncture: the end of the tightening cycle is upon us, while economic indicators in the US and Asia remain largely constructive. The uneven and weaker-than-expected recovery in China, due to the property slump, has come as a negative surprise. But overall, the global macroeconomic backdrop should support risk-on sentiment and we continue to unlock opportunities by focusing on quality and fundamentals.

We’re pleased that our investment themes for Q3 have been working well and they will continue to set our direction of travel. Still, some fine-tuning is in order to reflect the latest developments in the investment landscape. Compared to what we saw last quarter, earnings and inflation are in much better shape in the US. That allows the Federal Reserve to be one of the first central banks among developed markets to pause interest rate hikes, while others should follow suit before year end.

The good news is that the Fed has managed to complete its tightening mission without triggering a recession and we think the US market will stay in a “soft landing” scenario for the time being. Even though rate cuts are not likely to happen right away (we expect the first one in Q2 2024 in the US), markets may anticipate them sooner rather than later.

What does this mean for investors?

Historically, equities and bonds tend to do relatively well after the final rate hike. Typically, they perform better than cash in the 6 to 12 months following the final rate hike, particularly if a recession is avoided in the process. Therefore, we continue to put our cash to work in high quality medium duration bonds to lock in attractive yields and we also continue to invest in global stocks.

Still, investors need to be selective, considering the wide divergence in fundamentals among markets, sectors and companies, as well as the substantial run-up in equity valuations. Don’t just focus on the valuation numbers, but evaluate the forces driving them up and compare them against previous data. If you do so, you will notice that US equity valuations, which are boosted by technology and the enthusiasm for AI, are still below their 5-year average, while India’s high valuations are supported by their high return on equities. Nevertheless, betting everything on tech or a single market is never a sound investment strategy, regardless of the market situation. So, here are the four investment themes for the coming quarter.

We look at relative earnings strength, valuations and structural trends for opportunities

First, we believe the current climate still presents a good time to lock in attractive yields on medium duration investment grade bonds as they are poised to deliver favourable returns when markets start to anticipate rate cuts. US Treasuries also look attractive, especially after yields recently rose a bit too much due to supply concerns and strong economic data.

Second, we prioritise markets with strong fundamentals to maximise potential gains. In developed markets, we prefer US over European equities. In the East, we see upside in India and Indonesia, and take a diversified approach to leverage the local dynamics and ongoing growth trajectory in Asia. Even though the pace of recovery in China is below expectations, policy support and valuations remain compelling, and we think a neutral positioning is now warranted.

We also see sense in broadening our sector exposure to undervalued opportunities. While popular investments often come with a hefty price tag, we believe investors can look beyond the big tech names and find value in quality companies in the “peloton” of consumption, industrials and financial stocks that sit in their slipstream.

Finally, proactive and forward-thinking investors could do well by paying attention to climate change and biodiversity. The public policy and regulation on these issues will fuel a climate of innovation and investment acceleration, creating many opportunities for investors to participate in the coming sustainability revolution.

In conclusion, a clearer outlook for interest rates and inflation should continue to be good for risk assets but, as we know, financial markets can be full of surprises. To find the best risk-adjusted returns in the current environment, we continue to focus on quality investments with strong fundamentals and remain diversified. As always, we strive to help investors identify the upcoming opportunities and risks, so that they can position their portfolios for the best outcomes.

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Investment themes

We believe the Fed has finished its rate hike cycle and will pause until Q2 2024. As markets start to anticipate rate cuts, bonds will benefit while cash returns will decline. In fact, investment grade (IG) and Treasury yields have reached their multi-year highs, providing a good entry point to lock them in for a medium duration.

We overweight investment credit across developed and emerging markets and Treasuries with maturities up to 5-7 years.

Although valuations of US and Indian equities are relatively high, they’re well anchored by stronger growth prospects, and we prefer quality assets over cheap assets. In a world of slow growth and high interest rates, markets with solid fundamentals and quality companies with strong market positions and healthy balance sheets typically fare better than others.

We prefer the US over Europe, and favour India and Indonesia within Asia.
We take a selective approach and focus on the service-consumption and travel-related sectors in mainland China and Hong Kong. Valuations remain attractive.

Investors can diversify beyond technology in search of sustained returns. High-quality companies in the consumer discretionary and consumer staples sectors could be attractive given the strong US labour market, China’s reopening and Asia’s favourable demographics. Financials should also benefit from peaking rates and cheap valuations. Most large banks have delivered positive earnings results this year.

We maintain a cyclical tilt and overweight technology and consumer discretionary across regions.
We see value in the financials and industrials (Global and US) and healthcare (US).

In the US, the government’s emphasis on infrastructure and sustainability is driving private investments into clean energy. Similarly, many of the Chinese government’s long-term initiatives to foster domestic innovation are linked to the energy transition. The growing recognition of the importance of biodiversity will also open up huge investment opportunities.

We prioritise the long-term structural shift towards energy transition, with a focus on renewable energy, green infrastructure and energy efficiency.
We’re optimitstic about the diversification benefits and long-term returns in sustainable agriculture, responsible forest management and the circular economy.

Regional market outlook

The US economy remains resilient, with more positive momentum than that of other developed countries. The strong labour market, falling inflation and renewed optimism in the housing sector are all boosting consumer sentiment. Meanwhile, the re-onshoring of production and government stimulus plans (e.g. domestic production of microchips and the net zero transition) continue to support corporate investment. These factors should offset the impact of high interest rates. We also believe that fears of tightening bank lending standards should not be exaggerated.

We therefore think a recession this year will be avoided. This, in turn, should allow the rally in US stocks to broaden beyond the big tech-related names into other sectors. O

Over the next 6 months, we’re overweight on:

US equities and technology in general, as well as consumer discretionary, industrials, financial and healthcare stocks that have lagged the tech rally
US investment grade corporate bonds (medium maturities)

The Eurozone economy has generally disappointed in 2023 because of weaker domestic demand and lower-than- expected exports to China. The European Central Bank has been catching up with the US rate hikes, damaging the region’s growth outlook and investor sentiment, and the absence of a large European tech sector is also holding it back. We’re therefore underweight on Eurozone stocks.

Overall, we’re neutral on the UK equity market, which is dominated by global companies. However, we’ll be very selective about the market’s smaller or more locally focused companies, given that UK consumers are under pressure from sticky inflation and the continued decline of the country’s housing markets.

We’ve a neutral stance on UK equities due to persistent inflation and pressure on local consumers. We’re underweight on Eurozone equities.

EM EMEA economies have been hurt by rising US rates, with local currency weakness negatively impacting investor returns year-to-date. The EMEA region continues to suffer from the Russia-Ukraine war and the Eurozone’s weak economic growth. That said, Turkey’s recent switch to more conventional monetary policy has led to a partial recovery.

Latin America’s interest rate cycle is ahead of the US,and rate cuts are now well under way. That is supporting equity and bond markets in the region, and we remain overweight on Latin American stocks. While China’s slow recovery has so far capped Latin America’s exports, an acceleration of Chinese growth in late 2023 and in 2024 should be a positive for the region.

Over the next 6 months, we’re overweight on:

EM Latin American equities, particularly Mexican and Brazilian equities

China’s equity market has underperformed many global peers as economic momentum has disappointed. Fiscal and monetary policy support should reduce the risk of a big economic downturn and stabilise activity, but property market issues will continue to weigh on

sentiment. So, in spite of low valuations, we hold a neutral view until private sector investment improves and earnings pick up, which should eventually bring back investors.

Both India and Indonesia are benefitting strongly from global supply chain diversification and good cyclical momentum. India has a vibrant start-up culture and Indonesia is extracting increased value out of its commodities.

Over the next 6 months, we’re overweight on:

Asia ex Japan equities, especially Indian and Indonesian markets, and Asian investment grade corporate bonds (medium maturities)

Japanese equities have had a strong run year-to-date. But the weakness of the Japanese yen is a key factor, so the stock market’s performance is somewhat less exceptional when converted into US dollars. In addition, the Bank of Japan’s move to allow government bond yields to rise up to 1% is a step towards normalizing its ultra-loose monetary policy. That could lead to upward pressure on the Japanese yen, reducing the value of foreign sales made by domestic companies and weighing on earnings and stock prices. Moreover, given the strong run-up in Japanese stocks so far this year, investors could decide to take profit. For all these reasons, we’ve a neutral allocation to Japanese stocks.

We retain our neutral stance on Japanese equities due to tepid growth expectations and the potential for policy tightening.

Key data to watch

Source: HSBC Global Research as at 1 September 2023. Estimates and forecasts are subject to change. India inflation forecasts are fiscal year.

Source: Bloomberg, HSBC Global Private Banking as at 1 September 2023. Past performance is not a reliable indicator of future performance.

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Investment Outlook: HSBC Perspectives Q4 2023

Broadening opportunities amid a diverging growth outlook

Investment themes

1. Lock in attractive bond yields for longer

2. Focus on stronger fundamentals

3. Broaden sector exposure to capture upside

4. Leverage innovation and sustainable investment

Regional market outlook

United States

Eurozone and UK

EM Latin America and EM EMEA

Asia (ex Japan)

Japan

Key data to watch

We expect a downward trend of inflation and divergence in growth across markets

Treasuries and investment grade bonds are trading at attractive yields and the end of Fed rate hikes should help their performance

This year's equity market rally has been largely driven by rising valuation multiples. Earnings delivery will become increasingly important

Related Insights

Investment Outlook: Think Future 2023 Mid-year Edition

China in Focus: China’s evolving energy mix

ASEAN in Focus: The big inflation reversal

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