S.4 Ep.2: Forever in Your Debt - Investment Risks in an Era of Big Spending
US debt of $34 trillion—and counting—has the potential to wreak economic havoc. How do debt and government spending impact financial markets?
After three consecutive tumultuous years for financial markets, ongoing monetary tightening by central banks and persistently high inflation have increased the odds of a global recession. It’s never been more important for investors to take a long-term view of their portfolios. The investment ideas offered in the fourth annual PGIM’s Best Ideas report reflect the convictions of PGIM’s portfolio managers across a range of asset classes from equities to real estate, who together manage more than $1.2 trillion in assets for investors around the world.
In this webinar, PGIM experts discuss various investment opportunities and long-term trends covered in the report, against the backdrop of macroeconomic uncertainty challenging today's market.
Here are four key takeaways:
Don’t take a “soft landing” for granted: With the European Central Bank and Federal Reserve both sounding hawkish in December, investors might want to rethink bullish expectations of a soft landing.
“The Federal Reserve itself has an economic forecast that is consistent with inflation nicely coming back to target in a couple of years, unemployment rises a little bit, but there's no recession,” said Dr. Sushil Wadhwani, chief investment officer for PGIM Wadhwani and a member of the UK Chancellor's Economic Advisory Council. “However, it behooves us to consider two other possible scenarios. One, the central banks have already done too much, but we don't know it yet. If one looks back at historical tightening cycles, it's not unusual for the economy to just suddenly crumble. The second scenario, which I think is much more likely, is one where inflation turns out to be resilient. The Fed pauses, and then finds two or three meetings later that it has to tighten again. The central banks will be a very important factor in ensuring that markets don't get carried away too much.”
Agile diversification remains a priority: With the outlook for equity and bond markets still very uncertain, investors may want to consider an agile global macro strategy – selecting both long and short positions in assets less correlated to the overall market while factoring in profound changes in market sentiment or expectations – which will provide flexibility to react nimbly as conditions shift.
“Macro strategies, in general, comfortably outperformed conventional assets in 2022,” said Wadhwani. “We know from history these strategies have tended to do well in the run-up to recessions and coming out of a recession. In an environment with significant recession risk, you're going to need the diversification provided by macro strategies.”
Look for a fixed income comeback: Last year brought short-term pain for fixed-income investors, but a reallocation back into bond markets is approaching as rates begin to peak.
“The tail risks of a deep recession and big fallout are significantly lower than they were at peak fear in the third quarter,” said Edward Farley, head of the European Investment Grade Corporate Bond Team at PGIM Fixed Income. “When you look at fundamentals in the investment grade market, balance sheets are really strong, companies didn't lever up post COVID and banks’ net interest margins will go up with higher rates. If rates are going to settle down at these levels and you don't believe that you're taking significant amounts of extra credit risk, then investment grade can be at an attractive entry point. That is where we've seen inflows.”
European opportunities emerge: The European bond market’s underperformance versus the US has left spreads generally trading at more attractive levels in Europe. As volatility persists, the relative-value opportunities among European corporate bonds are broadening.
“There's clearly more upside in Europe,” said Farley. “If you believe that Russia/Ukraine war resolves itself, or gas will not be a problem at all, and that Europe manages to avoid recession, then actually Europe's really attractive. But you have to balance that — if it goes wrong, the detrimental impact on European corporates will be higher than then their US counterparts.”