The big picture

Resilience keeps recessions at bay, but will that continue?

Global economic activity has proved stronger than seemed likely at the start of the year, given the scale of supply-side shocks that had fuelled inflation and eaten into disposable incomes over the previous 12 months. Several indicators suggest growth accelerated in the first half of 2023 as a drop in energy prices lowered headline inflation.

However, the current economic cycle is likely nearing its end. Even though energy prices have fallen sharply, leading central banks have not yet won their battle to control underlying inflation. That suggests interest rates will continue to rise.

This ‘late-cycle’ environment could persist for a while longer, should the global economy continue to defy expectations with its unexpected resilience. All the same, major developed economies still look set for below-trend growth in the second half as the impact on household finances of higher rates saps spending.

Central banks are striving to tighten monetary policy sufficiently to weaken labour markets, deliver softer wage growth and ultimately lower core inflation without causing an economic downturn. However, it is important to recognise such periods usually end with too much policy tightening and recession.

What this means for asset allocation


Most equity markets have risen by between ten and twenty per cent this year, with some markets, such as Japan, as well as US technology, faring even better. Sensing that interest rates were close to peaking, and global economic growth was better than expected, investors have been snapping up shares. Company earnings, which have tended to surpass expectations, have helped demand. In the short-term, we are optimistic on equity markets’ prospects, particularly in Europe as earnings are expected to hold up better and valuations are more attractive. But we are more cautious further ahead given the risk of recessions.

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Figure 2. Asset allocation - Equities

Government bonds

The outlook for government bond markets looks more favourable than three months ago given the extent to which further interest rate increases have been priced in. The obvious, and increasing, danger that higher rates eventually tip economies into recession means we are now overweight this asset class. We see potential opportunities in the US since US interest rates are probably closer to peaking, while UK gilts are in a similar position given a further aggressive hike in interest rates is priced in. Emerging-market debt, denominated in local currencies, may also offer opportunities given the likelihood some central banks will start cutting rates in the second half.

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Figure 3. Asset allocation - Government bonds


We are neutral on corporate bonds. The extra yield relative to government debt looks fair given healthy corporate profits and low default rates. But expectations a recession will be averted has led investors to bid up the price of corporate debt. The late stage of the economic cycle and risks those hopes will be dashed means bonds could be judged expensive. Having issued a lot of debt at ultra-low interest rates in recent years, companies have not been rushing to refinance. But this could change in 2024 and 2025, which could be problematic if this coincides with recession.

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Figure 4. Asset allocation - Credit


We remain overweight cash. Although real rates of interest are negative, there is a prospect of earning a positive rate of return in the not-too-distant future as inflation falls and central banks continue to raise rates. In any case, holding cash helps protect portfolios and allows investors to reallocate when better opportunities present themselves.

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Figure 5. Asset allocation - Cash

Key investment themes

1.  Inflation persistence and uncertainty

Returning inflation to central bank targets in a way that minimises economic damage is proving challenging, although some progress is being made. The potent mix of adverse supply-side influences, caused by the pandemic, international trade disruptions, and energy and food price shocks, have all eased.

Welcome as these developments are, attention has switched to stickier core inflation. Whereas until recently supply-side factors were crucial, increasingly it appears excess demand is now the dominant influence.

To varying degrees, central banks recognise this and are tightening policy to suppress demand. It remains to be seen how much pain will be required to get inflation back to targets of around two per cent. But policymakers are mandated to deliver low inflation and they need to stay the course, even if that means parts of the economy suffer.

2. Global fragmentation

An array of increasingly deep-rooted forces are pushing nations in the direction of self-interest and confrontation. Sanctions, tariffs and other restrictions are a reality and important considerations for investors.

Growth in global flows of goods, services and capital have reached some sort of hiatus (see Figure 7). The same is probably true of key elements of migration flows. Globalisation was not without blemish – not everyone gained, and it may have contributed to greater inequality in some places. But the overwhelming evidence is that its benefits far outweighed any costs.

The obvious danger is that deglobalisation will result in long-term losses for all, or nearly all. A recent compilation of research into the possible impact from economic and trade fragmentation estimated the long-run impact at between two and 12 per cent of global GDP.

Figure 7.

3. The return of industrial policy 

While fiscal policy has come back into fashion in recent years, it is especially noteworthy that industrial policy is staging a comeback. It aims to support or encourage industries viewed as strategically important.

As Figure 8 shows, many countries are already investing heavily in several areas. There are many different drivers, including the threat posed by China, the need to secure supplies of key goods, tackling climate change and the development of new technologies.

These government initiatives are likely to frame the global environment in which commerce and trade take place in the future. They may cause friction between some countries or regions, with some fearing a return to protectionism, unfair state aid and support for national champions. However, most simply reflect the new direction for some government priorities.

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House View Q3 2023

PDF 5.9 MB 29 pages

The global economy has proven to be more robust to supply-side shocks that have increased inflation and reduced disposable income. While growth has slowed, we have not seen any major economy enter recession.

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Transcript  for video #

Hello everyone, and welcome to the Aviva Investors Q3 House View webcast.

I’m joined by David Nowakowski, Senior Strategist within our Multi-asset and Macro team.

The focus of the markets is on the growth side and a hard landing risk, which, luckily, has been pushed off and maybe decreased in probability.

I also have with me Baylee Wakefield, Portfolio Manager of Multi-asset Funds, and she’ll be providing our view on the impact that we believe the macro-economic backdrop has on markets.

Overall, those late cycle dynamics can see equities outperform.

But we have to be aware of the risks that can also create.

There could potentially be material downside risk.

Please join us for the Aviva Investors Q3 House View Webcast.

Transcript  for video #

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About the House View

The Aviva Investors House View document is a comprehensive compilation of views and analysis from the major investment teams.

The document is produced quarterly by our investment professionals and is overseen by the Investment Strategy team. We hold a House View Forum biannually at which the main issues and arguments are introduced, discussed and debated. The process by which the House View is constructed is a collaborative one – everyone will be aware of the main themes and key aspects of the outlook. All team members have the right to challenge and all are encouraged to do so. The aim is to ensure that all contributors are fully aware of the thoughts of everyone else and that a broad consensus can be reached across the teams on the main aspects of the report.

The House View document serves two main purposes. First, its preparation provides a comprehensive and forward-looking framework for discussion among the investment teams. Secondly, it allows us to share our thinking and explain the reasons for our economic views and investment decisions to those whom they affect.

Not everyone will agree with all assumptions made and all of the conclusions reached. No-one can predict the future perfectly. But the contents of this report represent the best collective judgement of Aviva Investors on the current and future investment environment.

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