Real returns will be hard to find, risk has not disappeared, and real assets should be favored
We are of the opinion that from a long-term investor point of view, the main focus should be to identify which types of assets would perform well and which ones would be adversely affected in the event of a long and severe recession. This is predicated on the assumption that our base case is a short, sharp recession in the US and a longer, milder recession in Europe with a commensurate global slowdown. In this base case, a myriad of risk assets will perform well and relatively consistently. There is, however, a material chance that this base case is vastly too positive. In a bearish or acutely bearish scenario (let us remind ourselves that almost no one predicted inflation would even rise to these levels), markets will need to reprice extremely significantly in some asset classes. In our view, real assets such as commodities, gold, inflation-linked bonds, selective real estate, and equities should be favored. Relatively sleepy parts of Fixed Income offer much better return for risk, and within portfolios, we would use caution in the face of the deglobalization trend. Active management will be of value as multinational companies would be adversely affected while domestically focused businesses would benefit from deglobalization.
Finally, investors should decide when it is time to change course. This decision should be based on probability, taking history into context, and related to cross-asset risk premiums. Depending on valuations, such as risk premiums, some risks may be worth taking despite the challenging situation. Contrarily, other asset classes may need to be shunned entirely because the risk premiums do not reflect the future risk paths. As individuals and responsible institutions, we need to act and prepare for a positive outcome. At the same time, we should start planning for the right asset mix with the goal of protecting our portfolios from the negative consequences of a protracted severe recession or those related to the emergence of deglobalization and a bipolar world.