Futures markets are suggesting that the Fed will begin cutting rates in late-2023 and more aggressively in 2024, he continued. In US equity and credit markets, still positive earnings growth is expected for 2023 and credit spreads approaching pre-pandemic 2017 to 2019 averages are consistent with a soft landing in the US economy rather than the recessionary rate cutting cycle priced in Fed Funds. 

Such inconsistencies across US asset markets suggest that investors should expect volatility in US assets in the months ahead as the likelihood of a recession or soft landing becomes clearer. “This favors our allocation to hedge funds which should benefit from such cross-asset repricing,” he said. 

In contrast, eurozone and China economies have seen catalysts for an economic rebound emerge over the year end, driving higher valuations and stronger currencies in early 2023. 

Despite this rebound, valuations in global equities outside of the US broadly and for the eurozone area and China equities in particular remain below historically average valuations suggesting that this should not be a return headwind ahead, Villamin continued. 

However, rising policy rates in Europe stand in contrast to the broad-based policy easing taking place in China. This combined with historically large dividend, buyback, and capital return policies among key Chinese companies suggests that the tailwinds for earnings here are more pronounced compared with other parts of the world looking ahead. 

So, while bonds continue to offer better value than equities in both Europe and the US, global equity investors can potentially find more attractive risk-reward in non-US assets and non-US dollar exposure to drive total returns in the months ahead, he said.

Global economy/asset allocation
Developed countries look set to face weak yearly growth, with potential for a shallow quarterly recession in the first half of the year, he continued. China’s reopening should lead to a strong rebound in growth driven by domestic demand. Inflation in developed countries is expected to decline further but core inflation could be resilient due to prices in services and tight labor markets. 

Villamin expects the main global central banks to hike key rates further and maintain a restrictive policy stance.  As a result, despite the impressive rally in January, the firm is staying cautious on equities given the deteriorating corporate earnings prospects and elevated valuations in the US in particular. He is also continuing to shelter in hedge funds to provide some cushion from equity volatility. 

Fixed income 
Government bonds were volatile over the past two months, but lower inflation risks, and less hawkish central banks fueled some easing in yields. Yields still look more attractive than in the past years and Villamin continues to argue in favor of rebuilding positions in fixed income segments as part of a diversified portfolio. 

“Credit is the preferred asset class within fixed income and compared to other risky assets. Carry strategies offer attractive returns and a favorable risk reward balance,” he continued. 

Equities/alternatives 
Earnings' estimates as well as equity valuations are currently pricing in a “soft landing.” Even in that scenario, further cuts to earnings' estimates will be inevitable in the coming months, notably on the back of strong downward pressures on margins. This is unlikely to be offset by a further extension in valuation multiples. 

Hedge funds are particularly valuable for generating alpha in markets should volatility re-emerge as we expect, he said. Credit longshort strategies should benefit from the high absolute carry, elevated fixed income volatility and increased single credit dispersion, he added.

Widening gap China and US-Europe
Although global growth is poised to be weak in 2023, fears of a deep recession in several countries have declined, Villamin said. The eurozone faces limited quarterly GDP contractions due to a mild winter to date and resilient services. Weak US consumption and capex are expected, as momentum falters in light of the recent deterioration. 

Asia looks in a better shape than developed countries as a strong rebound in domestic demand is expected in China. Domestic demand in the US and Europe are likely to remain weak in the first half of the year. Meanwhile, the reopening of the Chinese economy will give a boost to domestic growth. A strong rebound in consumption, services and industry will result, pushing activity above its potential in the next quarters. He has upgraded the firm’s 2023 Chinese growth outlook from 5.2 per cent to 6 per cent. Stronger Chinese demand should also boost activity in Asia as a whole, while exports to developed countries may remain sluggish, Villamin said.

Extending duration in bonds and adding commodity in equity   
With inflation likely to be easing from its peak level, the pressure from the Fed should stabilize looking ahead. He extended the maturity of the firm's fixed income holdings especially in the high quality credit space to lock in the attractive yield levels. 

In the equity space, Villamin added commodity exposure to participate in the next commodity super cycle. Years of underinvestment, China reopening as well as geopolitical tension are the main drivers, he said. The weakness of the dollar should also add some tailwind for the sector.  He further trimmed the firm’s dollar exposure. The dollar is on track to reverse its strong appreciation of the last two years as inflation pressure is easing faster in the US. Although the dollar has already depreciated more than 9 per cent since its September high, there is still some downside risk, Villamin concluded.