Michael Kelly, global head of multi-assets at PineBridge Investments, discusses the outlook, his asset class convictions and positioning.

Michael Kelly at PineBridge Investments believes that banking woes remain a key concern for the Federal Reserve, which is inclined to view upcoming credit tightening as a substitute for further policy rate hikes. 

“Wage pressures show no signs of abating, productivity is chronically underperforming, and super-core inflation appears to be reaccelerating, so we think it’s a big bet to assume credit tightening will fine-tune the economy to just the right degree,” he said in a statement. 

Despite the prevailing view that “everyone is bearish,” he believes that markets appear quite bullish, considering the narrowness of credit spreads, a razor-thin equity risk premium, and three rate cuts priced in for 2023. Kelly remains cautious. Economic tightening is a slow, cumulative process, and he expects US rates to settle higher for longer while the Fed’s balance sheet begins to shrink again. 

In his view, China offers a partial offset, and its consumption-led recovery will help most emerging countries make headway even with less spillover benefits than in China’s prior investment-led recoveries. 

“The global economy may be entering a period of more frequent and adverse supply shocks, particularly concerning energy and climate transitions and US-China decoupling. These trends could lead to lower trend growth, persistently tight labour markets, and greater risk of de-anchoring of inflation expectations. Consequently, we could see increased volatility in real and nominal interest rates and policy outcomes,” Kelly said.

He summarises the trends and developments which could affect his positioning.

Equities
Kelly adopts a more cautious stance on broader developed market stocks, particularly given today’s overvaluations combined with looming credit tightening, increased risk aversion by banks, and a reversal in the Fed’s balance sheet from its current rise.

He remains constructive on emerging market equities, especially Chinese equities, an area where he sees accelerating cash flows without monetary pullback, and caution priced into markets, in contrast with likely declines in both cash flows and liquidity in the US and Europe, which carry more demanding valuations. 

Fixed income
He believes that the Fed’s focus will be on addressing lapses in regulatory supervision and reversing the temporary surge in its balance sheet, with rates settling higher and terminal rates maintained for longer. It will also continue balance sheet declines through quantitative tightening despite pausing policy rate hikes. 

“Asia high yield currently presents an attractive opportunity to earn higher carry with very low duration. Compared to US high yield, Asia high yield offers less breadth but higher spread with declining, rather than rising, credit issues. This makes Asia high yield an appealing alternative for investors seeking higher returns in the fixed income space,” Kelly said.  

Alternatives 
“Accelerating domestic growth in China offers a positive outlook for commodities, but a potential recession in the US and Europe may dampen prospects for commodities broadly,” he continued. Within “green commodities,” he sees a high dispersion of expected returns. He believes aluminium and cobalt are very attractive, while lithium appears unattractive. This can be attributed to the significant divergence in supply growth, with less-appealing markets suffering from a glut of supply coming onstream due to prior investments.  

He believes that new vintages in the private credit market will benefit from the regional bank pullback. Fresh capital is now enjoying a widening addressable market with better credit terms and more attractive pricing. In Kelly's view, this may present selective opportunities for equity-like returns in fixed income.