London, 22 March 2023 — Russell Investments’ strategists believe a mild recession in the United States is likely over the next 12-18 months. Strong household and corporate finances are likely to limit a downturn that will also make the eurozone vulnerable.

“The collapse of Silicon Valley Bank highlights the dangers from aggressive central bank hikes. The Federal Reserve’s new Bank Term Funding Program should prevent SVB’s problems from flowing onto other banks. We expect that the Fed will undertake at least one more 25 basis point rate hike in the next few months,” said Andrew Pease, global head of investment strategy at Russell Investments. “However, the banking system shock should also act as a form of monetary tightening through stricter tighter lending standards.”

“The forced takeover of Credit Suisse by UBS demonstrates how quickly confidence effects can undermine the global banking system, adds Pease. “We think the actions taken by the authorities in the United States and Europe should be sufficient to eventually calm investor nerves.”

The Fed faces a daunting task to achieve a soft landing that sees wages growth and inflation cool without causing a recession.

“Given there remain some significant challenges it would be unwise to sound the all-clear on the global growth outlook. Those long and variable lags are still in play. Historically, it has taken an average of around two and a half years after the Fed’s initial rate hike for a recession to commence,” Pease said. Russell Investments’ key asset class views for Q2 2023 include:

• Indications of an uncertain equity market outlook but a favorable outlook on government bonds.
• US investment grade and high yield credit spreads, which are trading at or inside their long-run averages, are likely expensive and treasury yields of 4-5% look increasingly attractive.
• Equity investors may cheer the initial signs of labour market cooling on hopes for a Fed pivot. Historical experience, however, suggests that a soft landing will be difficult to accomplish.
• The British pound is undervalued against the US dollar but may struggle with further gains in the near term with the Bank of England becoming less hawkish.
• Large-cap UK equities offer good value. Exposure biases to defensive sectors may turn into a headwind in the near-term but they are attractive on a longer-term basis.
• Japanese bonds do not look attractive with the fair value yield for the 10-year bond at around 1%.

“Despite attractive valuations, we remain cautious on Chinese equities. Sentiment has moved too far ahead of the cycle and value fundamentals. Technical indicators suggest the market has overshot to the upside in the near term and there are signs of overconfidence from the drumbeat of analysts upgrading their forecasts for the Chinese economy”, Pease said.

At the end of Q1 2023, Russell Investments’ cycle, value and sentiment investment decision-making process points to an uncertain global equity market outlook. The team’s conclusion for equities is that the cycle is poor, value is expensive to at best fair value and sentiment is neutral.

Meanwhile, the team’s process concludes that government bonds are attractive, as the cycle is turning supportive with inflation set to decline and central banks potentially pausing in the next few months. Value is positive after last year’s selloff. Sentiment is supportive with data from the Commodity Futures Trading Commission (CFTC) highlighting that most investors hold short-duration positions (i.e., they expect yields to rise). This is supportive from a contrarian perspective.

The firm’s strategists summarise their current asset-class preferences as follows:

• Equities have limited upside with recession risk on the horizon. Although non-U.S. developed equities are cheaper than U.S. equities, Russell Investments has a neutral preference until the Fed become less hawkish and the U.S. dollar weakens.
• Emerging market equities are tracking the performance of the U.S. dollar and a recovery seems likely only once the Fed has stopped tightening and the U.S. dollar begins to decline. China’s reopening has helped Chinese stocks rebound but there are question marks over the longer-term outlook given the headwinds from the property market. For now, a neutral stance is warranted.
• High yield and investment grade credit spreads have widened following the turbulence caused by the Silicon Valley Bank collapse and are above their long-term averages. Spreads will come under upward pressure if U.S. recession probabilities increase and there are fears of rising defaults. The Russell Investments’ team has a neutral outlook on credit markets.
• Government bond valuations have improved after the rise in yields during 2022. U.S., U.K. and German bonds offer reasonable value. Japanese bonds are still expensive with the Bank of Japan holding the 50-basis point yield limit. Russell Investments’ methodology has fair value for Japanese Government Bond yields at around 100 basis points. Yields have risen sharply in most markets in recent months. The risk of a further significant selloff seems limited given inflation is close to peaking and markets have priced hawkish outlooks for most central banks.
• Real assets: REITs valuations remain attractive relative to infrastructure and global equities, although the gap has become smaller. REITs should perform well when interest rates fall, given that real estate fundamentals appear reasonably healthy. Commodities should benefit from the China reopening. The boost is likely to be smaller than for previous China rebounds since infrastructure/construction is expected to drive less of the growth in 2023. The energy outlook is murky, given the demand destruction from a potential global recession and the supply constraints from the sanctions on Russian output. Gold looks fully priced, given its relationship to real interest rates and with inflation risks diminishing.
• The U.S. dollar has risen modestly this year on Fed hawkishness. It could weaken if inflation begins to decline and the Fed pivots to a less hawkish stance. The main beneficiaries are likely to be the euro and the Japanese yen. The yen could also appreciate strongly if the new BOJ governor Kazuo Ueda moves away from the current yield curve control strategy.

For more information, please see the Q2 2023 Global Market Outlook

About Russell Investments

Russell Investments is a leading global investment solutions firm providing a wide range of investment capabilities to institutional investors, financial intermediaries and individual investors around the world. Building on an 86-year legacy of continuous innovation to deliver exceptional value to clients, Russell Investments works every day to improve the financial security of its clients. The firm has £230 billion (or $276.5 billion, or €259 billion) in assets under management for clients in 32 countries. Headquartered in Seattle, Washington, Russell Investments has offices in 19 cities around the world, including in New York, London, Paris, Toronto, Tokyo and Shanghai (all figures as of 31/12/2022).

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