Insurance Insights Q1 2023: Macro outlook

In 2020 we had the pandemic and last year it was the invasion of Ukraine. This year it is bank failures/crises that have necessitated multiple write-downs and repricings. Even before these events, we were preparing for a more defensive stance based on our belief that we are back in the contraction phase of the cycle, which has historically favored defensive assets.
While we don’t know if the recent bank collapses/crises are isolated incidents, it is interesting that they are all coming at once, after a period of calm. Many of these banking emergencies can be traced to the lax monetary policy during the pandemic era that encouraged risk taking and the unintended consequences of an abrupt and rapid reversal of financial conditions starting in 2022. This would suggest that the banking sector volatility may not be over.
Putting all of this together, we think market participants can anticipate some negative spillover effects to the broader economy. We expect that the interest rates that banks pay to depositors are likely to go up while US Treasury rates and other government bond rates will fall as depositors become more aware of their available rate and risk options. This should place downwards pressure on banks’ net interest margins that could drive more consolidation in the industry and less credit expansion in the economy.
This all means that we continue to be in a contractionary part of the economic and market cycle and the recent banking crisis reinforces this view. These incidents demonstrate that the Fed’s tightening cycle is starting to take a toll. We know that monetary policy has around a 12 to18-month lag and so I expect certain segments of the economy – such as small cap companies without easy access to liquidity - to start feeling the impact soon. If we believed there would be no more banking “accidents”, we may be willing to add risk to our asset allocation. We don’t and conclude that the uncertainty further justifies our defensive approach. We favor defensive assets such as cash, short-term government bonds, investment grade bonds and gold.
From a regional perspective, we continue to prefer emerging market assets. This is partly because we find them to be relatively cheap (which boosts long-term potential, in our opinion) but also as a hedge in case we are wrong about being in the contraction phase of the cycle.
From a currency perspective, we think the US dollar is expensive and that the Japanese yen is cheap. Given our belief that Fed tightening is coming to an end, we expect the dollar to weaken. If the Bank of Japan starts to normalize, we think the yen could appreciate notably.

Source: Bloomberg, US Federal Reserve. Data as at 28 Feb 2023.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.