Healthcare Opportunities in 2023 and Beyond
The pace of healthcare innovation could position the sector to be the next decade’s secular leader.
The recent bout of financial instability set off by the collapse of Silicon Valley Bank seems to have been allayed by the Federal Reserve’s swift contagion-limiting actions, with stock markets steadying yet pricing in a somewhat higher probability of an eventual recession in the US. Fixed income markets, too, appear to reflect more confidence in a recession and/or lower inflation. Debt ceiling negotiations in the US are an additional concern that could help precipitate a recession.
Inflation is slowing and is likely to be substantially lower this year compared to 2022. Nevertheless, wage inflation remains elevated at rates that don’t align with the Fed’s 2% inflation target. Add to that the financial sector difficulties, and inflation could be allowed to stay higher for some time if central banks put the brakes on interest rate hikes to ensure financial sector stability. And in the longer run, rising “green” investment and higher defense spending following Russia’s aggression suggest that inflation is likely to be higher over the next 10 years than it has in the last 10.
As market volatility and concerns about interest rates and inflation transform into recession concerns, we feel there are three plausible scenarios for the US economy that we judge each warrant having a significant probability attached to them, depending upon both the macro-economic outcome and policymakers’ reaction to it:
Given the three scenarios, what are the asset class implications one could expect? We believe the possibilities are as follows:
Above we discuss the possibility of a “quick” recession caused by financial stress. Historically, this type of recession has been painful for equities, so while sovereign bonds typically held up well, 60/40 portfolios struggled. But there’s the possibility of a different scenario: Fed tightening is paused for a time, but inflation remains too high for comfort, and the Fed therefore resumes interest rate hikes, eventually leading to a recession. This recession scenario, where inflation surprises positively on the upside, is very bad for a 60/40 portfolio because both equities and bonds decline. We saw this in 2022 and in prior periods of high inflation, like the 1970s.
The added diversification of liquid alternatives has historically benefited investors, as trend following and macro strategies have tended to do well in both recession scenarios described, as compared to a 60/40 portfolio. Over the last 50 years, trend following has outperformed the 10 worst periods for 60/40 portfolios. So, for example, a 60/40 portfolio was down more than 15% in 2022, while a trend following portfolio was up more than 15%.
But what if a recession doesn’t materialize and instead, we get a soft landing? Liquid alts strategies are very adaptable and can adjust as the probability of a soft-landing increases. In such a scenario, they may not do as well as a 60/40 portfolio but are still likely to deliver a positive return. Liquid alts can be thought of as a form of relatively costless insurance: providing protection when a 60/40 portfolio does poorly, but still generating positive returns when a 60/40 portfolio does well. And it’s important to remember that times of outperformance for 60/40 portfolios often represent attractive entry points for liquid alts strategies – a sort of “two steps forward, one step back.” We’ve noted that 2023 might represent a low point in headline inflation, with inflation rising again in 2024 and 2025. If that turns out to be the case, it won’t be surprising if a 60/40 portfolio does poorly again, and liquid alts outperform.
We think that, on average, investors are still not diversified enough in their portfolios, with most relying quite heavily on 60/40 strategies and allocating too little to systematic macro strategies, which have a very low correlation with conventional assets. In the current environment where there is significant recession risk, these strategies can be especially valuable. But even if a full-blown recession doesn’t materialize, managed futures have the potential to make money and protect portfolios. We believe that the last stages of a tightening cycle, financial fragility, and a potential recession could generate significant opportunity for managed futures strategies for the balance of 2023 and beyond.
Investors are facing a host of challenges in 2023, but ones that look far different than what they confronted over the past decade.
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