Allianz Research h s a l p s n n U a o k s n i s o a K n n a o y J o b t Capital Markets o h P Too early to re-risk! 2022 was an unmitigated disaster for capital policy rates cushion downside pressures on valuations and markets. The combination of higher interest rates allow for some long duration positioning. However, the despite slowing growth led to an unprecedented price rebounding momentum will be short-lived as fiscal support correction in both equities and fixed income. This left is gradually withdrawn going into 2024, with most asset investors with no place to hide and effectively killed classes slowly converging to (but not reaching) their long- any ex-ante diversification benefit, resulting in unseen term average returns. high interest-rate volatility. In this context, market fractures have started to appear, such as the recent In this uncertain environment, the expected correction turmoil in the UK Gilt market, as funding becomes in illiquid alternative assets has been overlooked. Less expensive and scarce. Despite not representing, as of transparent valuations and limited trading make them at today, an imminent systemic risk, the combined effect risk of being most severely hit in case investors are forced of high volatility and higher funding costs, amplified to sell. Because of this, and as liquidity drains and the by leverage and concentration risk, could set off a so- recession approaches, the likelihood of negative surprises called “liquidity spiral”, with funding needs triggered by in these segments continues to be high. The good news is falling prices increasing demand for safe collateral to that by late 2023, the global economy and markets will cover margin calls and shore up liquidity buffers. start leaving behind three years of extreme market and economic instability to start forming, once again, a much- The current volatile market dynamics are likely to spill needed but still timid structural cyclical positive trend over into the first half of 2023 as investors attempt to (Figure 11, following page). front-run the recovery path. Our economic scenario warrants a defensive tactical short-term positioning and hold-to-maturity investment in quality fixed income in the near term. During the second half of 2023, subsiding inflationary pressures and stabilizing 20