A SAFE strategy for 2023

Manpreet Gill Chief Investment Officer of Africa, Middle East and Europe

25 Jan 2023

Explore the market drivers likely to shape outlooks this year

In 2023, we believe investors across the Middle East and Africa should adopt a ‘SAFE’ investment strategy. The global investment environment has always been an important backdrop influencing the region’s economy and markets. This year, we expect this backdrop to create both headwinds and tailwinds as the US and Europe are likely head into a recession, while China recovers strongly after reopening its economy.

Our SAFE investment strategy, devised to mitigate the headwinds and ride the tailwinds, comprises four components: a) Securing one’s yield using today’s higher bond yields; b)  Allocating to long term value, which we currently see most visibly in Asian equities and Asia USD bonds; c) Fortifying portfolios against economic and market surprises through high quality bonds, gold and cash; and d) Expanding beyond traditional assets, taking advantage of the relatively lower correlations offered by some alternative strategies, such as hedge funds and private credit.

Three main drivers for the Middle East and Africa

For the Middle East and Africa regions, we see three global market drivers that are likely to shape the region’s outlook this year.

The first is the US dollar. As I’ve written before, we often underestimate the pivotal role of the USD in influencing the price of assets worldwide.

In 2023, we expect the dollar to weaken as the US’s interest rate advantage over G10 peers starts to moderate. While the Fed is likely to take policy rates a little above 5% before considering a pause, markets are likely to price this pause well ahead of the fact (albeit after a month or two of two-way consolidation).

Historically, weak US Dollar environments are usually positive for emerging market equities, bonds and currencies as more global investor capital flows to these regions. For the Middle East and African economies and markets, we believe this will be a tailwind this year.

The second driver is energy prices.

One of our core economic views is that we expect the US economy to enter into a recession. Unsurprisingly, slower US growth tends to lead to slower global growth overall. One area this is likely to have the most significant implication is in energy prices. Historically, a drop in energy demand due to a US recession usually causes energy prices to fall towards their production costs, even if only briefly. For net energy importers, this is still likely to be a tailwind.

However, unlike previous cycles, we are entering 2023 with much lower-than-usual energy inventories and spare capacity. Moreover, China’s re-opening could also offset slower Western demand to a significant degree. Together, these suggest prices may fall by less than one would normally expect in a recessionary period. Thus, a US recession this time is likely to be less of a headwind than usual for the net energy exporters in the Middle East and Africa.

The third driver is risk appetite.

Our view that the US economy falls into recession in 2023 and that global equities (outside of Asia) have not yet bottomed are both likely to be economic and market headwinds for Middle East and African equity markets, at least early in the year. That said, we are likely to have two key mitigants. The first is China’s economic reopening-led rebound. While the impact of China is unlikely to fully offset slower demand in the Developed Markets, it is likely to help mitigate it to a significant extent. The second is a weaker US Dollar. As we discussed earlier, the resultant shift in capital flows towards emerging and frontier markets is likely to be a key source of support for capital markets in the Middle East and Africa.

On balance, we expect the tailwinds in the form of increased capital flows into Emerging Markets, as result of a weaker USD, and resilient energy and commodity prices, supported by China’s strong economic recovery, to be positive for financial assets in the Middle East and Africa this year. However, it pays to adopt a SAFE strategy in investment portfolios as recessions in the US and Europe loom.