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Investment Perspective · 06.16.23

From Concern to Churn

We are now underweight equities globally as recession conditions develop in Europe, U.S. valuations hover above long-term fair value, and China struggles with its economic recovery.

  • Portfolio Construction
  • Stock Market
  • Federal Reserve
Executive Summary

Key Points

What this is

We outline our portfolio positioning after banking sector concerns have waned, the U.S. government reached a debt-ceiling deal, and the European economic outlook has worsened.

Why it matters

The decline in debt-ceiling and banking-sector risk has boosted U.S. equities, which now appear expensive based on our estimates of fair value.

Where it's going

We are now underweight equities in our global portfolio model, based on our outlook over the next year.

U.S. equities performed well over the past month as the resolution of the debt ceiling and further passage of time without additional regional bank issues reduced the level of concern on display in the market, including a drop in the equity market “fear index” (VIX) to pre-pandemic levels. Market leadership continues to be very narrow, however, with the seven largest stocks in the S&P 500 accounting for more than all of the year-to-date gains. The question for investors is whether the rest of the U.S. equity market will start to participate — leading to further upside for stocks broadly — or the U.S. equity market will merely “churn” — with profit-taking in big tech (and tech-adjacent companies) used to fund a broadening of performance, capping overall return potential at the index level.


The removal of the “left-tail” risk has also repriced interest rates. Most notably, the front end of the yield curve has moved markedly higher as investors backed out odds of material rate cuts. While we believe the Fed is at/near a peak rate for this cycle, the continued durability of the labor market and sticky core inflation should keep rates elevated into next year. And, with equity valuations above long-term fair value (on earnings that do not yet seem to be factoring in recession), we see limited equity market return upside in the base case.


The outlook for Europe has worsened somewhat. Recessionary conditions are approaching, but the European Central Bank (ECB) has yet to shift from their path of continuing to increase interest rates due to sticky inflation. This increases the odds of a policy mistake in Europe, where monetary policy will be tightened beyond the point necessary, instigating additional economic weakness. Meanwhile, China continues to display a very sluggish recovery — causing some speculation that the government will have to increase stimulus.


With interest rates moving toward the high end of our expected range, we narrowed the size of our underweight to investment grade bonds. This was funded by a reduction in developed ex-U.S. equities, reflecting the accumulating headwinds in Europe. As such, we are now  underweight equities across all three major regions. We have been encouraged by more durable fundamentals in the U.S. — but believe valuations are too elevated with the global economy approaching stall speed. We maintain our overweight positions in high yield bonds and natural resources — alongside a small overweight to cash.



The VIX Index — a gauge of equity market “fear” — declined to pre-pandemic levels over the past month.

vix index peaks and valleys

Source: Northern Trust Asset Management, Bloomberg. Data for the CBOE Volatility Index (VIX) from 6/12/2018 through 6/12/2023.

Interest Rates


The resolution of the debt ceiling was a relief for the U.S. Treasury market, but this was not the only driver of recent price action on the front end in our view. Yields on U.S. Treasuries maturing in two years have risen over 80 basis points (bps) from trough to peak in the past five weeks. Concurrently, for July are now 25 bps higher than they were at the beginning of May, while overnight rates at the end of the year are now only expected to fall 25 bps from their peak as opposed to the more than 65 bps expected at the beginning of May.


Concerns over the stability of the banking sector waned over the period, while economic data releases generally surprised to the upside. More specifically, non-farm payroll growth was stronger than expected in both reports released during the period, while core inflation increased. Reduced fear around spillovers from the banking sector to the real economy and a robust labor market keep the Fed’s focus on inflation and markets repriced accordingly. All of these factors resulted in an active period for the front end of the yield curve, with fewer expected rate cuts this year consistent with our long-held views for an extended pause by the Fed once they reach their peak policy rate.


  • Interest rates repriced higher on the back of a debt ceiling agreement and banking sector stability.
  • We are slightly less negative on term (interest rate) risk following the recent upward moves. 
  • With interest rates near the top end of our forecasted range, we reduced our tactical underweight to Investment Grade Fixed Income (from 6% to 4%). 



Interest rates and Fed expectations have increased.

expected 2023 year-end fed policy rate compared to 2 year treasury yield

Source: Northern Trust Asset Management, Bloomberg. Expected 2023 year-end Fed policy rate implied by Fed fund futures contracts. Data from 5/1/2023 through 6/7/2023.

Credit Markets


Despite elevated uncertainty from the bank sector, debt ceiling, Fed policy and the economy, the high yield asset class has performed well in 2023. As of 5/31/2023, high yield has returned 3.7% versus the S&P 500’s 9.6% gain this year. However, investors should think about returns on a risk-adjusted basis. One metric to measure this is Sharpe ratios. Sharpe ratios are annualized returns versus volatility, or more simply the return per unit of risk. The focus for long-term investors should be getting fairly compensated for the risk they are taking.


As seen in the nearby chart, over a 25-year horizon the high yield asset class has a far superior Sharpe ratio than equities, making high yield an attractive asset class for multi-asset portfolios. It is also an efficient way to gain exposure to credit risk and generate income. High yield has historically demonstrated a lower beta than equities, minimizing the potential downside capture if uncertainty and volatility persists or remains elevated. And — with all-in yields near 9% as the Fed nears the end of its rate hiking cycle — high yield provides an attractive income option in a flat economic growth environment where global equities may be rangebound. We maintain a notable overweight to high yield in our .


  • High yield has delivered higher risk-adjusted returns than U.S. equities over the past 25 years.
  • With the global economy approaching stall speed we value high yield’s ability to compensate for risk-taking.
  • We prefer credit risk over both market (equity) and term (interest rate) risk; high yield remains the largest tactical overweight in our global policy model.



High yield has done well on a risk-adjusted basis.

25 year sharpe ratio

Source: Northern Trust Asset Management, JPMorgan. JPMorgan U.S. High Yield Index and S&P 500 Index used. Data as of 3/31/2023. Past performance is not indicative or a guarantee of future results. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index.



Global equities were buoyed last month by the resolution of the debt-ceiling negotiations and a surge in optimism related to the likely beneficiaries of the rise of Artificial Intelligence (AI). The overall return for global equities of 2% masked a large regional dispersion with surging Japan rising 5%; the technology-heavy U.S. market rising 4%; emerging markets rising 1%; and the value-oriented European market falling 3%. The disappointing outcome for the latter region was also related to relatively weak economic data and the news that Germany had slipped into a recession. This, combined with several hawkish statements made by the European Central Bank (ECB) put investors on alert after a strong run in the previous months.


Looking ahead, it will be important to monitor the risk of central banks overtightening monetary policy in the face of a global economic slowdown. The Fed is more likely than not to pause over the summer, but the ECB is at risk of being too backward-looking and continuing to hike rates. The outlook for economic growth and how it translates to revenue growth will also be closely watched, with a slowdown baked into expectations but not a recession. We have a cautious bias in our expectations and have reduced our developed ex-U.S. equities position to underweight. 


  • U.S. equities did well last month, helped by excitement on artificial intelligence and the debt ceiling agreement.
  • We see less upside to equities given higher valuations in the U.S. and worries on European economic growth.
  • We reduced Dev. ex-U.S. Equities from equal-weight to -2% and are now underweight all three equity regions.  



AI hype has helped the tech-oriented U.S. equity market.

1 month equity returns comparing japan, u s, emerging markets and europe

Source: Northern Trust Asset Management, Bloomberg. One-month total returns as of 6/6/2023. Past performance is not indicative or a guarantee of future results. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index.

Real Assets


After outperforming in 2022, the natural resource (NR) asset class has materially lagged broader global equities thus far in 2023. Nearly all of the underperformance has occurred the past three months – as Debt Dislocation risks weighed on global economic demand expectations. With the debt ceiling deal passed and regional banks stabilizing, the Debt Dislocation risk case is gone. And while some of the resulting economic growth damage may still be on the come (less government spending and regional bank credit extension), we believe NR has other support beams than just the removal of this big risk to the global economy.


Perhaps the biggest support beam for NR is the lack of recent investment. The nearby chart shows the subdued global oil capital expenditure over the past near-decade — global mining capital expenditure has shown a similar pattern. Alongside focus on price stability, we see it likely that oil prices maintain a floor near current levels — allowing for continued cash flows that are going back to the balance sheet — or to shareholders. Near term, we view NR as a better investment than emerging market equities. Longer term, constrained supply alongside new sources of demand (green transition) and inexpensive valuations make NR attractive in its own right.


  • Natural resources (NR) has lagged equities so far this year mainly on the back of economic growth concerns.
  • We see several near-term and long-term supports to NR, with constrained supply as a key support beam.
  • We made no changes to our +3% tactical overweight to NR this month.



Oil capex has declined over the last ten years.

global oil capex in billions comparing north america to global exclusing north america

Source: Northern Trust Asset Management, Bernstein, Jefferies. Data from 2009 through 2022. Estimates from 2023-2025.

Base Case Expectations
Risk Case Scenarios
Global Policy Model chart

Source: Northern Trust Capital Market Assumptions Working Group, Investment Policy Committee. Strategic allocation is based on capital market return, risk and correlation assumptions developed annually; most recent model released 8/10/2022.The model cannot account for the impact that economic, market and other factors may have on the implementation and ongoing management of an actual investment strategy. Asset allocation does not guarantee a profit or protection against a loss in declining markets.

Unless noted otherwise, data in this piece is Sourced from Bloomberg as of June 2023.

Main Point

Our base case: limited equity upside

While we believe the Federal Reserve is at or near its peak rate for this cycle, the durable labor market and sticky core inflation may keep rates elevated into next year. And, with the U.S. equity market valuations above what we believe is long-term fair value, we see limited upside in the equity market.

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Northern Trust Asset Management (NTAM) is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.


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