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Portfolio > Economy & Markets

How to Navigate the ‘Slightly New Normal’ in 2023

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Once financial markets consider inflation to be under control, stocks and bonds should return to their long-standing negative correlation — moving in opposite directions — Columbia Threadneedle’s North American asset allocation chief predicted this week, recommending investors seek resilient companies as markets find a “slightly new normal” next year.

“Back to normal for asset allocation means a return to diversification between stocks and bonds, and expectations of positive returns for both asset classes over the medium-to-long term — even if we’re starting at dramatically higher interest rates,” Joshua Kutin wrote in a blog post Thursday.

“This is good news for multi-asset portfolios, which really struggled in 2022, as correlations between stocks and bonds turned positive. But I also think we’ll have a new normal that involves being more selective within these allocations.”

Kutin noted that the multi-decade relationship between stocks and bonds broke down in 2022,  posing performance challenges for multi-asset portfolios. While the positive correlation between stocks and bonds will likely continue into 2023, he wrote, investors should expect a return to negative correlations when investors are convinced inflation is under control.

Shifting correlations and the possibility of recession and long-term high inflation underscore the need for investors to consider risk allocation in multi-asset portfolios and diversify within asset classes rather than deciding only between stock and bond classes, according to Kutin.

Among U.S. stocks, small cap appears more interesting than large cap heading into 2023, he wrote. ”Small caps have greater exposure to domestic revenue and could outperform, especially when we think about the relative strength of the U.S. economy versus other regions,” he said.

Global investors might find appealing valuation opportunities in emerging markets compared with developed regions, especially Europe, which faces greater uncertainty because of Russia’s war in Ukraine, according to Kutin.

In fixed income, high yield assets may pose greater risk than investment grade or securitized debt, he wrote.

“You need to be sure that you have an active approach to identify resilient companies,” Kutin said.

He cited an opportunity for investors to use fundamental analysis to find buying opportunities in battered stocks and bonds, and noted companies that are poorly positioned for a downturn will struggle more in a difficult economy. “Rather than big asset class bets, it will become much more important to check under the hood within each asset class to identify robust sources of alpha,” he wrote.


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