Harbor Multi-Asset Solutions Q3 2023 Asset Allocation Viewpoints Summary
In consideration of the macro environment, we continue to expect a recession over the next twelve months and believe the risk to assets is skewed negatively. We remain in favor of high-quality companies and high-rated fixed income exposures.
The combination of slowing profits, declining margins, higher interest rate prospects, and valuations above historical averages makes for unattractive risk-reward in the equity market, in our view.
- We believe that U.S. large cap equities are currently overvalued, and earnings estimates remain optimistic. As a result:
- We think risk/reward for equities remains unfavorable.
- We expect negative earnings revisions to resume in the second half of 2023.
- We think equities look expensive relative to interest rates.
- Our preference is for growth over value, given slowing aggregate demand, peaking interest rates, and inflation falling from elevated levels. Our tilt is towards sectors where valuations are attractive, earnings have already reset and potential for positive earnings revisions.
Fixed Income & Credit
We retain our overweight to fixed income and high-quality exposures as return prospects far surpass equities, but remain neutral duration overall.
- The swift fall in inflation from 9% to 4% marks significant progress towards the Fed’s price mandate. That said, progress on more persistent sectors of inflation is less clear. We see elevated risks to credit as markets continue to be too optimistic about the timing and likelihood of Fed rate cuts.
- We continue to think that we are more likely in an extended business cycle rather than the beginning of a secular productivity shift driven by artificial intelligence, given the time required to adopt new technology.
- We believe the risks in the banking sector and commercial real estate still linger under the surface.
Where We’re Weighted
We remain most overweight in Fixed Income, specifically in Agency mortgage-backed securities, which continue to offer significant relative value as the economy slows and rate volatility normalizes.
We remain most underweight Equities, specifically in the U.S. and Western Europe. We find U.S. large caps to be expensive with downside risk to earnings estimates and while we believe small- and mid-caps in the region possess attractive relative valuations they remain exposed to an unfavorable risk environment. In Western Europe, we believe the region’s cyclical value exposure will underperform as economic momentum slows.
- We upgraded our rating for Japanese equities given attractive valuations, a favorable inflationary backdrop, and improving corporate governance.
- We downgraded our rating for
- Western European equities given cyclical value exposure which should underperform as economic momentum slows.
- Emerging Markets (EM) equities as valuations appear attractive, but the reopening tailwind has stalled.
- EM Debt, specifically lowering our overweight to local currency EM debt as rate differentials narrow.
Global growth remains below trend.
- A strong services sector offsetting an ongoing manufacturing recession.
- A resilient housing market due to secular demand and limited inventory; despite elevated mortgage rates still stifling existing home sales.
- Central banks’ efforts to slow aggregate demand taking hold as first half 2023 spending moderated from 2021/2022 levels.
- The expiration of student loan forgiveness, tighter credit standards, a weaker labor market, and a trickling up of excess savings are potential headwinds to spending.
Fed’s focus remains on inflation.
- Near-term rate cuts unlikely due to a tight labor market and firm wage increases, in our view.
- Credit conditions weighing on interest-sensitive spending (homes, capital expenditures), though wealth buffers and strong corporate profits reduced economy’s reliance on credit growth.
- Expiration of student loan forgiveness and rise in non-mortgage delinquencies suggest increasing vulnerability to tighter credit, while lower nominal growth and higher real wages are contributing to declining corporate profits.
Since peaking last summer, inflation has declined materially.
- Decline driven by lower energy and food prices, improved supply chain conditions, and decreased demand for goods.
- Despite progress, the labor market has not cooled, and wages have not declined sufficiently enough for the Federal Reserve to contemplate interest rate cuts, in our estimation.
Regional Banking Crisis
Despite the alleviation of regional banking concerns, the issues that resulted in bank failures linger.
- Aggregate deposit balances are shrinking and losses on held-to-maturity assets remain.
- Interest rates put pressure on net interest margins, impacting the profitability of regional banks.
- However, bank funding strains are normalizing.
For Institutional Use Only. Not for Distribution to the Public.
The views expressed herein are those of the Harbor Multi Asset Solutions Team at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. These views are not necessarily those of the Harbor Investment Team and should not be construed as such. The information provided is for informational purposes only.
Past performance is no guarantee of future results.
The information shown relates to the past. Past performance is not a guide to the future.
All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Bonds may decline in response to rising interest rates, a credit rating downgrade or failure of the issue to make timely payments of interest or principal. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets.
Fixed income securities fluctuate in price in response to various factors, including changes in interest rates, changes in market conditions and issuer-specific events, and the value of an investment may go down. This means potential to lose money.
As interest rates rise, the values of fixed income securities are likely to decrease and reduce the value of a portfolio. Securities with longer durations tend to be more sensitive to changes in interest rates and are usually more volatile than securities with shorter durations. Interest rates in the U.S. are near historic lows, which may increase exposure to risks associated with rising rates. Additionally, rising interest rates may lead to increased redemptions, increased volatility and decreased liquidity in the fixed income markets.
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This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.