Johanna Kyrklund, London-based group CIO at Schroders, thinks a recession will hit the U.S, later this year, but is more upbeat other regions as the global economy undergoes a "regime shift" after the era of free money.
The recent strains on the U.S. banking sector including the collapse of Silicon Valley Bank are among the factors suggesting that interest rate hikes are "starting to bite, and we expect banks to tighten credit conditions further," she said.
Ms. Kyrklund said in an email Tuesday that she expects the recession to "last a couple of quarters," and the Federal Reserve to "shift to an easier stance" as inflationary pressures continue to ease.
Conditions in the rest of the world, however, are more positive, she noted.
"For example, Europe has avoided recession this year as energy prices have been lower than expected and China is emerging from its lockdowns," she explained.
However, she assured, from an investment perspective, actively managing this current market cycle can uncover "fresh opportunities."
"It's important to remember that historically some of the best opportunities for equities occur in the midst of recessions," she said. "Markets always move ahead of economic news."
Funds raised in recession years, she added, can "target assets at depressed values, to be realized in the recovery phase when valuations are rising."
For now, the principal concern she hears from institutional investors concerns the level of inflation.
"We believe that inflation is clearly in the process of peaking, but we would argue that, in the medium term, we are likely to see higher levels of inflation compared to what we got used to after the financial crisis," she added. "We believe the world is experiencing a profound period of change as a regime shift in the financial economy, challenging investors for whom the era of free money from unorthodox central bank policies has become deeply embedded in our behavioral biases and decision making."
Looking at subsectors of the investment universe, within fixed income, she said a number of emerging markets are further along in the battle against inflation and have reasonably solid macroeconomic fundamentals.
"Given the high level of yields, particularly in local currency-denominated bonds, and the level of underinvestment in this asset class due to turbulence over the last decade, we see opportunities for 2023," she said.
She added that it can't be assumed that fixed income will be negatively correlated with equities over the medium term.
"However, with the repricing of yields in 2022 and the risk of recession in 2023, we think that fixed income offers an attractive source of yield and diversification," she stated.
Ms. Kyrklund also said she had a "neutral view" on equities.
"Although peaking (interest) rates provide some relief to equity valuations and earnings expectations have begun to moderate, we are concerned that the twin risks of recession and of further financial stress have yet to be adequately reflected in valuations," she warned. "In this environment, it will be prudent to keep some dry powder for the opportunities likely to appear."
She is particularly cautious when it comes to exposures to sectors like technology, where "margins are vulnerable to further tightening in financial conditions and declining liquidity." The divergence in economic conditions around the world leads her firm to emphasize regional diversification in equities.
"Both Europe and China present interesting opportunities in this light, particularly with economic activity in China continuing to accelerate after reopening from COVID-19 lockdowns," she said.
Schroders had $887.2 billion in assets under management as of Dec 31.
