Given current valuations and the potential macro scenarios from here, CIO thinks fixed income looks well- placed for the second half. (UBS)

There is a path higher for stocks, but it is a narrow one, in our view, and comes with risks: Economic growth can neither be so strong as to force the Federal Reserve into further rate hikes, nor so weak as to drive fears of a recession. Our preferred asset class is fixed income.

2023 has so far been characterized by resilience.

  • Equities: The S&P 500 has rallied around 25% from its October low, led by a handful of stocks linked to artificial intelligence.
  • Economy: US inflation slowed and economic growth held up well in the face of Fed rate hikes.
  • Earnings: Second-quarter corporate results have been favorable, and we expect them to mark the trough in year-over-year profit growth.

But we think investors face a balancing act from here.

  • The S&P 500 is already pricing in a lot of positive news, in our view, setting the bar higher for the rest of the year.
  • Economic growth is likely to slow in the second half.
  • The lagged effect of interest rate rises is still feeding through to the US economy.

Amid an uncertain environment, we prefer quality bonds to equities.

  • We like higher-quality bonds—including high grade and investment grade—given decent yields and uncertainty over the economic growth outlook.
  • Thematically, we focus on earning income (e.g., through dividend-paying stocks), and identifying cheaper parts of the equity market that have lagged in the rally (e.g., emerging markets, defensives, and value).
  • We have a most preferred view on gold, and a least preferred view on the US dollar.

Did you Know?

  • The Federal Reserve hiked rates by 25 basis points in July, setting the fed funds target range at 5.25–5.5%, the highest since 2001.
  • Headline US consumer price inflation slowed to 3% y/y in June, the lowest level since March 2021 and down from a peak of 9.1%in June 2022. Core inflation, which excludes food and energy, stood at 4.8%.
  • The European Central Bank raised policy rates by 25bps in July, lifting the deposit rate to 3.75%.

Investment view

Given current valuations and the potential macro scenarios from here, we think fixed income looks well-placed for the second half. We like high grade (government) and investment grade bonds. Within equities, we prefer parts of the market that have lagged the rally this year. We expect the US dollar to weaken gradually, and hold a most preferred view on gold, which we see as a good hedge within portfolios.

Main contributors - Vincent Heaney, Alison Parums

Original report - How should I position for the second half?, 4 August 2023.