Expecting a soft, shallow recession to be the base case this year, UOB Asset Management (UOBAM) believes it is too soon for investors to be risk-on, although they do not have to be as conservative as they were last year.
As a firm, UOBAM has also reduced its cash levels and become “less negative” than it was in 2022. Believing that there would no longer be significant interest rate hikes moving forward, UOBAM has started to increase its holdings in fixed income, finding 6% yields in investment-grade corporate bonds, says director and head of multi-asset strategy Anthony Raza in an interview with The Edge Singapore.
Raza acknowledges that fixed income, as an asset class, has not been the most exciting over the past few years, especially in 2022, as investors were left with disappointing yields amid repricing and sell-off. However, yields have since risen as inflation slows down and central banks move closer to the end of their hiking cycle, making fixed income an attractive option for mitigation during the economic downturn.
“Historically, particularly bad years for fixed income are followed by years where the asset class performs well. This is not to say that we are ruling out potential headwinds from any possible future interest rate rises. And we do understand that cash is also yielding good returns — it is possible to get 4% returns from fixed deposits,” says Raza.
He adds that fixed income is particularly attractive on a risk and rewards basis in the near term, due to an expectation for the US debt ceiling to start weighing more on markets.
“The markets seem to be prepared for difficult negotiations and an eleventh-hour agreement like we saw in 2011. But we increasingly think it is more likely there is no agreement and we have government services closures that will hurt an already fragile economy.
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“We think a default can be avoided; but at that point of closures and significant fiscal drag, we think markets will become more risk-off and fixed income will perform better,” says Raza.
This follows cooling US inflation, which increases confidence in the market that the latest rate hike will be the US Federal Reserve’s last in the cycle. The Fed raised interest rates by a quarter percentage point on May 3, hinting that it may be the final move in the most aggressive tightening campaign since the 1980s as economic risks mount. The increase lifted the Fed’s benchmark Federal funds rate to a target range of 5% to 5.25%.
Following this, Raza says inflation is improving more than most people realise. The firm notes that the shelter data makes up 40% of the consumer price index data, significantly lagging real market data. Once the shelter data catches up to real world data, inflation should already be below 3%, he adds.
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“Additionally, the Fed is aware of the lag in the economic effects of monetary policy. They should now see what the effects of the past year’s rate hikes will have on the economy.
“We think the effects of the interest rate hikes are starting to become more apparent in the banking system and will continue to weigh on the economy in the coming months,” says Raza.
Despite believing that further hikes are unlikely, Raza says the resilience of the economy may be strong enough to not result in rate cuts.
Meanwhile, there are also concerns that the turmoil in the banking industry would cause a prolonged recession. The banking jitters — which have been ongoing since March, catalysed by the Silicon Valley Bank’s (SVB) run and the rescue of Credit Suisse — may have been overdone, says Raza. He adds that fears of depositor withdrawals and failures in US regulation have since dissipated, as there were measures put in place to ensure the depositors’ protection as well as address liquidity concerns for the affected banks which have restored the confidence in the system.
“I also take confidence that bank runs can be controlled. In fact, one of the Fed’s highest priorities aside from fighting inflation is preventing bank runs, and SVB’s case came as a surprise. This means that the scenario would serve as a good wake-up call,” says Raza.
Given that the UOBAM believes that the market is currently within the recession quadrant, Raza says the firm is reluctant to be overweight on equities. It is, however, reducing its underweight on the asset class.
Having analysed previous shallow recessions, Raza says the year 1990 stood out as one of the most similar to the current market landscape. At the time, equities corrected by 20%, before making all-time highs within the next six months. Using this as a blueprint, Raza says there is a possibility that the first half of the year is going to continue being a choppy market for equities before being followed by a recovery, which means that the opportunity to buy may be faster than expected.
“We are on guard looking for that point, although we are not sure when exactly that would be. There may be temptation still within the current first half of the year, but amid the looming recession and fear in the banking industry, we are recommending our clients to avoid being risk-on and simultaneously not to be overly negative in case opportunities arise,” he concludes.
