Royal Bank Premier Banking

Mid-year Investment Outlook 2023

Markets do well despite mixed signals

After a very difficult year in 2022, many developed economies started 2023 better than expected. The challenges faced last year, such as rising inflation and interest rates, seem to be behind us now – with the exception of the UK, where inflation is expected to fall in the second half of the year.  

New challenges up ahead

While rising inflation and rapid interest rate hikes might be subsiding, we could see new challenges emerging as a result of them. And investors have a likely US recession and declining corporate earnings to contend with.

Despite these challenges, markets have turned in a relatively positive performance over the first half of the year. But we’re basically seeing a lot of mixed messaging from the macro-economic data at the moment. 

A mixed picture

On the one hand we have oil prices falling despite supply cuts – indicating subdued demand, rising financing costs for consumers and businesses, and small US companies’ optimism at a decade low. While on the other hand, US and European growth is better than expected and corporate earnings are beating forecasts – albeit still falling. 

Meanwhile, the bond market is already pricing in a much weaker growth and inflation environment in the coming months, with an expectation that interest rates will make a U-turn and start dropping soon, something that would typically only occur during a recession. 

Encouraging results for investors

As for our own client portfolios and funds, they have performed reasonably well so far this year, reflecting the overall positive market performance. This is notably thanks to our large-cap equity and bond exposures which did particularly well.

A US recession still on the cards

In our Investment Outlook at the beginning of the year, we said we believed a US recession would be the main story of 2023. This remains the case – we still believe such a recession is likely. Our own recession indicator suggests one is on the way in the next 12 months. And in the past, when our indicator has been at the levels it’s at now, a recession hasn’t been far away, as you can see in the graph below. 

Labour market will be key

Another factor we’re monitoring closely as a potential indication of an imminent US recession is the country’s labour market. The US economy is heavily consumer focused – so a recession can’t come until there’s a rise in unemployment and consumption declines as a result. History has shown that the labour market tends to deteriorate as we near a recession, or just as one has started. 

The 'no recession' scenario

There is a possibility, however, that a strong labour market will support consumer demand and either delay the start of a recession or allow the economy to simply avoid one. The presidential election in 2024 could also play a role in averting a recession – as having one isn’t very conducive to getting votes – and the government could use fiscal policy to sustain a healthy level of economic momentum. 

Something needs to happen

The difficulty with these more benign scenarios is that they would likely prevent inflation from falling back to central banks’ preferred levels of 2%. It’s generally accepted that something needs to happen to reduce demand for goods and services for price pressures to decisively fall back to pre-pandemic levels. 

Rising interest rates take their toll

In a bid to tame above-target inflation levels, central banks have been raising interest rates at a rapid pace. And regardless of whether or not a recession is on the way, higher rates can shock the system and expose vulnerabilities. We’ve seen this in the US, where the Federal Reserve’s aggressive rate hiking unearthed concerns around systemic risks in the US banking sector. While those concerns were soon allayed, we’re still starting to see cracks in some interest-rate-sensitive sectors. 


Meanwhile, people appear to be eating away at their pandemic savings and taking on debt to keep up with inflation. As a result, a growing number of people are missing payments on their credit cards or car loans as they can’t keep up with rising costs. In the US, for example, the average used car loan payment for consumers is up 35% compared to its equivalent at the beginning of 2020, according to Citi and Cox Automotive. America’s low unemployment rate has been key in containing the impact of this. But once the labour market begins to deteriorate, consumer spending could decline, and with it the economy.  

US earnings face challenges

So how is all this affecting one of the key cornerstones of investing – company performance? Well, despite some challenges over the past six months, companies are actually faring better than expected.

Coming into 2023, company earnings were expected to drop significantly. But in the first three months of the year, they beat these – admittedly low – expectations. Earnings growth was expected to fall by 8%, but at the time of writing it had only fallen 3%.  

While this may seem like relatively good news, it does follow a 2% decline in Q4 2022. Also, analyst forecasts predict a 6% drop in Q2 this year, before flattening in Q3 and then finally rebounding to be up 7% in Q4.

This is a peak to trough of -3% between Q3 2022 and Q3 2023, which is by no means disastrous when compared to previous contractions in the past 50 years. Following the Global Financial Crisis in 2008, for example, US earnings contracted by roughly 50%.  

Our portfolio positioning

As we know financial markets have been under pressure for 18 months, we favour a cautious approach regarding our investments. 

For now, we’ve tilted our portfolios away from risk-sensitive assets and have a more positive bias towards government bonds. We do, however, think opportunities will present themselves later this year, which are likely to include small-cap stocks, emerging market equities, and perhaps even the banking sector.



Given the uncertain backdrop, we continue to hold a position in global healthcare given the sector’s defensive nature and relative resilience in recessionary and high interest rate environments. Despite our cautious approach, we’ll continue to monitor markets for good deals, with some valuations already reflecting the potential challenges ahead. Emerging markets, for example, seem under-valued at the moment, while showing signs of stabilisation and an economic recovery helped by China’s economy re-opening. We added to our emerging market equities exposure earlier this year.

Fixed income

Fixed income

We added to government bonds as signs of recession grew and the rate hike cycle appeared to approach its end. Fading inflationary pressures saw these bonds provide stability in portfolios during the volatile period in March. Our positioning favours US Treasuries, where interest rates are peaking, and shies away from Japanese government bonds, where there are tail risks associated with a potential shift away from easy monetary policy. Our client portfolios and funds also hold some diversification into short-dated emerging market debt. And we sold out of our financial credit allocation as US recession fears and monetary tightening generally don’t support such high yielding, riskier bonds.

Net zero in portfolios

Net zero in portfolios

We continue to progress on our journey toward 2050 net zero carbon emissions. Currently, average portfolio alignment against this ambition is 58% across our core investment propositions. This is ahead of our 2025 goal, and well on track to our 2030 target.

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