The end of another turbulent year is a time both to reflect and to make plans, with many thinking about their New Year’s resolutions

Now investors should get ready for when markets start to turn in 2023, according to UBS Global Wealth Management.

Mark Haefele, chief investment officer at the firm, has set out 10 resolutions aimed at helping investors navigate the rapidly changing environment the firm expects to continue in 2023.

Haefele thinks that now is the time to plan for the market inflections that will come in 2023. “Investors will need to pick their battles, keep focused on the bigger picture, and plan to add exposure over the course of the year," he said in a statement. “Rising yields have made fixed income assets more attractive as a source of income. With bond market volatility still high and economic growth slowing, we currently prefer the higher-quality segments." 

He sees 2023 as a good year to put new money to work in private markets, because investing in vintages after public markets peak has historically generated outsize returns. To start the year, he prefers defensive sectors within equities and higher-quality bonds, but expects the backdrop for investors to improve as 2023 evolves.

In the near term, the backdrop for risk assets is challenging: inflation remains high, interest rates are rising, and economic growth is slowing. But he expects 2023 to bring inflection points as inflation falls, central bank policy shifts from tightening to loosening, and growth bottoms. This should mean that the backdrop for investors will improve as 2023 evolves, Haefele said.

New Year’s resolutions
1. Pick your battles – policymakers will likely drive market inflections
Federal Reserve policy and China’s reopening path are likely to be important variables for markets in 2023, Haefele said, and investors will need to consider how their positioning fits with the directions of these policies.

The Fed slowed the pace of rate increases to 50 basis points in December from 75bps in each of its prior four rate decisions. But he still expects a further 50bps increase in the first quarter of 2023, with the risk of more thereafter. The Fed has said it intends to keep policy restrictive for some time, and the still-tight labour ­market, strong nominal wage growth, and higher number of job vacancies than unemployed mean inflation could prove stickier than hoped, preventing the Fed from cutting rates in 2023.

In his view, this means investors should tactically position more cautiously for now, but also prepare to shift. Cyclical and growth segments of the market and riskier credits will be more attractive as signs emerge that inflation may fall sustainably back to 2 per cent and that the Fed is considering looser policy, Haefele said.

In China, health authorities this month announced further easing on a range of COVID restrictions - another signal the country is edging toward reopening. This has come alongside additional assistance to property developers and more pro-growth statements from the Politburo. Recent economic measures have progressed faster than expected, but he still sees a bumpy transition to a full reopening. Public concern over the virus remains high and could be stoked further as infections strain hospital capacity over the winter. Therefore, he keeps a selective approach on China at this stage, focusing on individual winners from the reopening while staying ­neutral on the market overall.

2. Think about the bigger picture – long-term returns from here should be good
It can be easy to get wrapped up in the day-to-day. But a new year is a time when many of us get some time and space to think about the bigger picture, and for investors, that should mean a more encouraging perspective, Haefele said.

Fed policy and China’s reopening will be key market variables in 2023. After declines in both stocks and bonds this year, he expects better returns from here, he said. Central bank tightening has driven bond volatility and equity performance. This year, global equity valuations, as measured by the MSCI All Country World Index, have fallen from a 21.3 times 12-month forward price-to-earnings ratio to 17.1 times, while 5-year US Treasury yields have risen from 1.26 per cent to 3.65 per cent. Both suggest decent long-term returns for diversified portfolios.

Historically, current equity market valuations have been consistent with subsequent 10-year returns of 6–9 per cent per year. For bond markets, initial yields are generally a good indicator of subsequent long-term returns, suggesting that current yields - close to the highest since 2009-  should mean among the best long-term return outlooks in 13 years, Haefele continued. He recently upgraded his long-term return assumptions to account for these more favorable valuations.

This more appealing outlook means 2023 should provide a good opportunity to build up a diversified portfolio for the long term.

3. Stop procrastinating – plan to gain exposure and anticipate the inflections
Procrastination is a problem that many people try to solve in their new year’s resolutions. The same is true for investors. Waiting for precisely the “right time” to invest often results in missed opportunities to earn longer-term returns.

The macroeconomic conditions necessary for a sustainable rally may not yet be in place. But trying to time the precise day, week, or month when markets bottom is always challenging and could backfire if proven wrong. So for investors with excess cash balances today, he sees “phasing in” as an effective strategy for building expo sure to financial markets next year.

To do this, investors can use dollar-cost averaging and establish a set schedule to invest, Haefele said. 

Meanwhile, a strategy of investing capital immediately in bonds and then phasing into stocks is another approach that can reduce the opportunity cost of holding uninvested cash and potentially enhance investors’ ability to buy stocks if there is a market correction.

As well as considering when to put cash to work, investors also need to consider where to put it to work. In the firms base case, he expects broad equity markets to trade lower in the months ahead. But by this time next year, he thinks the backdrop will have improved in line with his expected inflection points in inflation, monetary­policy, and economic growth.

For more risk-tolerant investors looking to identify parts of the market that could rally most strongly when the inflection arrives, he sees select opportunities in early- cycle markets, “deep value” stocks, and the likely beneficiaries of China’s reopening. 

These include the broad German and Korean equity markets, parts of the semi- conductor sector, select companies exposed to China’s reopening, and currency structures that allow investors to navigate the turn in the dollar.

Recent market moves have shown that the US dollar is anticipating the changing macro environment relatively quickly, and the firm has moved its stance to neutral from most preferred. The Fed’s tightening cycle is moving closer to completion, which reduces potential US dollar upside, while lower US inflation has reduced the risk of a terminal federal funds rate that is significantly higher than the current market ­pricing of around 5 per cent, Haefele said. In addition, progress toward reopening in China creates room for growth to improve outside the US, particularly in Asia, lending support to more procyclical currencies.

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4. Get some insulation – add defensives and value
Adding home insulation has become a more popular talking point in Europe this winter amid elevated energy prices, Haefele said. With a backdrop of high inflation, rising rates, and slowing growth, he thinks some portfolio insulation for investors makes sense. Haefele prefers more defensive areas of the equity market - including consumer staples, healthcare, and quality-income stocks.

The consumer staples and healthcare sectors outperformed the MSCI All Country World Index (MSCI ACWI) by 9 and 11 percentage points, respectively, in the first 11 months of 2022. He expects both sectors to continue to outperform in the months ahead, given that they should be relatively resilient as economic growth deteriorates.

He also favours value stocks, which have outperformed growth stocks by 19 percent-age points in the first 11 months of 2022 (based on MSCI indexes). Inflation above 3 per cent has historically favored value stocks relative to growth, Haefele said, and value has also historically outperformed growth by an average of 4 percentage points in the 12 months following the Fed’s last rate hike of a cycle.

5. Boost your income – seek income opportunities
Haefele starts the year with a focus on more defensive areas of the equity market. With inflation still high, he expects value outperformance to continue. Rising yields in 2022 have made fixed income assets more attractive as a source of income. But with bond market volatility still high and economic growth slowing, he prefers the higher-quality segments of fixed income, including high grade and investment grade bonds. Haefele expects returns in the first half of the year to be largely driven by the yield on offer, which is 4.1 per cent for high grade and 5 per cent for investment grade bonds.

He also likes “quality-income” stocks, which combine higher-than-average dividend yields, a high return on equity, low earnings variability, and low debt-to-equity. Quality-income stocks have a defensive sector bias: Based on data going back to 1988, quality-income stocks (MSCI World High Dividend Yield index) have delivered an average 5.1 per cent annualized return while the ISM is below 50, compared with 1.4 per cent for the MSCI ACWI.

Also, elevated volatility can be used to earn additional portfolio income - for example, through premiums generated in structured investments or put-writing strategies, he added. Haefele sees opportunities to generate attractive premiums in individual stocks, in particular within the tech sector, where implied volatilities remain elevated. In the commodity space, he favours selling downside price risks in Brent crude oil or base metals, such as copper and aluminum, which should be supported by the reopening in China.

6. Cook with some new ingredients – seek uncorrelated hedge fund strategies
Cooking more often and trying new recipes are popular new year’s resolutions, and investors should not neglect the opportunity to consider adding new asset classes into their portfolios, either, Haefele said. In 2022, traditional bond-equity diversification failed to offer portfolios much protection from market events. But some hedge fund strategies fared much better: macro strategies, for example, returned 8 per cent on average in the first 11 months of the year [HFRI Macro (Total) Index], as managers successfully positioned long the US dollar and short rates and equities.

For investors, this underlines the importance of seeking alternative sources of return that are less correlated with broad market moves, Haefele said. Looking forward, macro strategies have historically performed well in periods of high implied volatility, capitalizing on market stress to generate annualized returns of 6.1 per cent, compared with an average loss of 11.3 per cent for global equities during those periods. 

He also thinks equity market-neutral strategies stand to benefit from divergent stock performance in 2023, while multi-strategy funds can offer a simple way for investors to build a diversified hedge fund allocation.

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7. Keep up with the news – position for the era of security
The most important geopolitical event of 2022 was Russia’s invasion of Ukraine in February, an event that has intensified a drive for self-sufficiency in strategically important areas such as energy, food production, and technological development.

While the firm doesn’t yet know what news 2023 will bring, this era of security will be one of the enduring trends of the decade, stimulated by measures like the US Inflation Reduction Act, which includes investments in green energy, and the CHIPS Act, which aims to boost domestic semiconductor production.

The global drive for energy security should favour investments in active commodity strategies, greentech, and energy efficiency, while efforts to improve food security should favour stocks linked to improving agricultural yields and water conservation, Haefele said.

Cybersecurity is another potential beneficiary of this trend. The sector is a relatively defensive part of the broader technology space, as companies and governments tend to maintain spending even in the face of economic downturns. UBS expects the cybersecurity market to grow by 10 per cent per year through 2025.

8. Invest in what you value most – invest sustainably
Many sustainable strategies underperformed in 2022 due to higher exposure to growth sectors, though their long-term performance remains strong on an absolute and relative basis. And fund flows to sustainable investments remain more resilient than the broader market. 

Haefele sees diversification within sustainable investments as key to improving the risk- reward of portfolios - and helping mitigate potential volatility over shorter time horizons. Investors can diversify across sustainable themes, including more value-oriented topics, alongside growth strategies; focus on ESG improvers, as well as companies that are already ESG leaders; and include sustainable bonds as counterweights to equity exposure.

9. Learn something new – seek value and growth in private markets
One of the most notable trends in financial markets over the past decade has been the growth of the private market asset class. The industry is likely to continue growing as companies opt to stay private for longer, and investors seek diversification, higher returns, and access to growth.

Private equity managers are likely to mark down their portfolios further in the months ahead. But it is unlikely that private investments will be marked down to the same extent as public markets. 

Haefele also sees 2023 as a good year to put new money to work in private markets because investing in vintages after public markets peak has historically generated outsize returns. 

For investors looking to augment their core private equity exposure, there are attractive returns for value-oriented buyout strategies with a focus on healthcare and technology. The trend toward a green economy is generating new investment strategies in a growing sector. Finally, secondaries could present both new and existing investors with a timely opportunity to enter the market at a discount.

Investors should also remember that investing in alternatives like private equity comes with certain drawbacks, including the risk of illiquidity, and investors need to be willing and able to lock up capital for longer, Haefele said.

10. Spend more time with family and friends – best wishes for the year ahead
Given the unprecedented disruption to everyone’s personal lives caused by the COVID-19 pandemic in recent years, Haefele's last resolution is to spend more time with family and friends over the holiday season and in the coming year.

"Being more sociable can benefits your professional life. Numerous studies point to a link between social skills and success in the classroom, being valued by employers, and entrepreneurial success," he said.