“Savings depletion and weakness among small-cap and regional bank stocks suggest that the U.S. economy may not be as strong as it seems.”

The story of 2023 has been the story of a U.S. recession deferred while the tourniquet of tightening monetary policy has begun to bite elsewhere—Europe in particular. U.S. consumers and corporations entered the year with robust balance sheets that made them surprisingly resilient to higher rates, while a shift from consumer-oriented support to industrial stimulus is preserving the fiscal impetus. Europe’s growth is weakening and the U.S. consumer may be tiring, but ultimately, the more time the economy has to adjust to the slowdown, the milder it is likely to be. Even so, the Asset Allocation Committee (“the AAC” or “the Committee”) retains the neutral overall outlook it adopted last quarter, while leaning further into its quality-oriented, “long-the-strong” stances at the margins and within asset classes. This is because markets appear to be focusing increasingly on the negatives of higher rates, sticky inflation, debt sustainability, tighter financial conditions and ebbing liquidity that have long dominated our medium-term views. Most notably, core government bond yields have broken out of their 2023 ranges, potentially shaking a key support for equity markets. In both equities and credit, we emphasize high quality. We prefer U.S. large caps and Japan to small caps, Europe and emerging markets. On yield curves, we think recent adjustments have created value for maturities of between two and seven years across developed markets, and prefer those maturities over longer-dated bonds in most countries—especially those where we expect investors to demand a higher risk premium on concerns about fiscal and debt sustainability. Cash remains a high-yielding haven as the market seeks a new equilibrium in rates and greater clarity on the potential for a global growth slowdown.