• This suggests that today’s higher inflation is structural, rather than cyclical. It’s likely here to stay, albeit probably not at the 40-year highs we saw in 2022. We also expect inflation to be more volatile going forward, with potential for more violent swings over time.
• This persistently higher, more volatile inflation backdrop may also signal the return of more frequent, less predictable economic cycles in the period ahead, driven in part by a supply side that may remain “sticky” even as demand tends to fluctuate sharply. 
• And global central banks may no longer be able to step in and "save the day” with interest-rate cuts and quantitative easing. Monetary policy is likely to be more restrictive going forward, potentially making central banks sources of volatility rather than stabilizing influences. Their struggle to balance growth and inflation will continue into 2023 and beyond. 
• As if there weren’t enough volatility-inducing forces at play, global geopolitical instability is also ramping up, with very real implications for the capital markets and investor strategies. The ongoing Russia/Ukraine conflict and China’s increased role on the world stage are two prime examples. These geopolitical uncertainties have contributed to the trend toward deglobalization.

The key takeaway from all of this is that investors will have to contend with looming economic recession risks in 2023, along with other longer-term considerations, and think about how they might need to position their portfolios accordingly. 

Seeking to minimize downside…

The hallmarks of this new macroeconomic era have contributed to a weakening of the diversifying relationship between equities and traditional bonds. Investors may no longer be able to count on the classic, often-reliable 60/40 equity/bond split to confer sufficient portfolio diversification. In fact, the historically negative correlation between the two asset classes turned positive in 2022 as both fell in tandem, adding risk to many investor portfolios.

Since conventional bonds may no longer provide the same amount of portfolio ballast as in the past, investors might benefit from searching for equity downside mitigation elsewhere; for example, in hedge funds or defensive equities that might better weather challenging economic environments. 

This is not to say that global fixed income has lost all its luster. However, investors may wish to reevaluate their existing fixed income allocations in favor of less traditional opportunities to pursue yield and total return in a risk-aware manner, such as within some higher-yielding credit sectors.

…and maximize upside potential

Despite the greater degree of uncertainty that attends seismic shifts in the macroeconomic landscape, there are always opportunities to be found. Notable thematic investment game changers to watch for in the future include climate change and sustainability, rapid digitization, and aging demographics. These big-picture trends create fertile ground for disruptive innovations and blossoming industries on which investors might seek to capitalize. What’s more, thematic equity investing could be an effective solution to rising economic and business cycle risks.

On the sustainability front, as climate-change mitigation and adaptation efforts continue to become ever-more important, several far-reaching ESG-related themes look poised to gain traction. These range from environmental initiatives like cleaner energy alternatives (e.g., electric vehicles) and biodiversity protection measures, to social and governance issues such as diversity, equity, and inclusion, human safety, shareholder rights, and cybersecurity. 

Another path to enhancing upside potential in investor portfolios may be through alternative investments, including both private equity and private credit to complement public-market allocations. The private-equity sphere, for instance, appears to have ample room for growth and may offer some attractive return opportunities.

The road ahead: Paved with possibilities

This past year may have marked the death knell for one macro regime and the birth of another. But with big, ongoing economic and market changes, no matter how uncertain or uncomfortable, come new possibilities for discerning investors. To wit, we believe the new investment setting may prove to be one that is well suited to skilled, active portfolio management.

For another view of our 2023 outlooks, please see Picture this: Our 2023 economic forecast in 5 charts.  This series of images captures key investable ideas across our macro, equity, bond, alternative, and sustainable investing outlooks.