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The “Black Rabbit” did not bring certainty to the markets. Although inflationary pressures are slowing and central banks seem increasingly willing to slow the rate hikes, analysts remain bearish in their forecasts.
Most bankers anticipate further challenges for US equities as a result of the economic and labor slowdown. The fact that the risk premium in the S&P 500 price is below historical averages points to investors not being adequately compensated.
High corporate earnings estimates, in turn, indicate that markets are not taking into account the challenges that companies are facing. The impact of monetary policy tightening, for example, has yet to be fully reflected.
Where to hide?
Morgan Stanley analysts suggest paying attention to fixed-income securities. For instance, investment-grade corporate bonds offer more than 5%. It should be noted that these are quality securities with relatively low credit risk.
There is also upside potential in fixed-income bonds. The economic slowdown could encourage investors to seek “safe havens,” including U.S. Treasuries and other higher-rated bonds, which would drive prices higher.
Emerging market equities could also be an alternative. The suspension of China’s “Covid zero” policy, the return to price stability, the fall of the US dollar, and cheap valuations compared to developed markets could play in EMs’ favor.
It is worth mentioning that developed economies are expected to slow to 1.1% in 2023, while EM economies are projected to grow by 3.7%. China’s recovery will also positively impact Asian and Latin American economies in 2023 in areas such as exports and tourism.
Talking about risks, Argentina, Ecuador, Ethiopia, Kenya, Pakistan, and Tunisia have a 10% or higher probability of default. In addition to weak fundamentals – most of them have debt in excess of 60% of GDP – the yield on dollar-denominated debt in most cases exceeds 20%.
Overall, volatility in EM securities is likely to remain high. The next rate hike by the Fed will put even more pressure on the market. Catastrophe, however, is not expected yet. On top of that, high nominal yields in many countries compensate for additional risks.
