Roadmap July 2023

Economies are wilting after a full year of interest rate rises. Pockets of financial stress are sprouting, and geopolitical tensions remain challenging for investors.

However, as these stresses fade over the next year, investors with long-term balanced and diversified portfolios should be able to withstand the immediate pressures, and potentially take advantage of opportunities created by any further volatility.

Some form of recession in the US is now the base case, but not every recession is a crisis. Most historical recessions, particularly those generated by central bank tightening, are relatively shallow and brief. US recessions tend to last only ten months on average, and equity markets trough around their midpoint. More severe outcomes typically only occur if there is a financial crisis. And the recent failures in the US banking sector do not appear to be a system-wide crisis like the GFC. In most major economies, the conservative lending behaviour and tightened banking regulation will not prevent isolated problems but will significantly reduce the prospects of broader contagion.

There are indicators that the next economic cycle will be strong. Three significant spending waves focused on the renewable energy transition, closing healthcare gaps, and re-evaluating manufacturing supply chains – are at their early stages and could last at least a decade. The Russia/Ukraine conflict is accelerating the energy transition in Europe. And a substantial wave of construction will begin in Australia, led by the Brisbane Olympics, the second Sydney airport and a range of major road and rail projects.

The current environment is a better entry point for long-term investors than two years ago. Expected returns are higher across almost all asset classes, including cash, government bonds and credit instruments, where yields have jumped with the rise in interest rates. In equity markets, valuations are well below 2021, and although there are short-term risks, the most significant determinant of the future return for equities is the price at your entry point – bearing in mind that markets are forward-looking and will move ahead of changes in the economic cycle.

All this means we need a balanced approach with one eye on the short-term risks and a focus on the long-term potential for markets, and long-term investment goals.