#Market Strategy — 10.05.2023

How to Recession Proof Your Portfolio?

Investment Navigator Asia Edition - May 2023

Prashant BHAYANI, Chief Investment Officer Asia, BNP Paribas Wealth Management & Grace TAM, Chief Investment Adviser Hong Kong, BNP Paribas Wealth Management & Dannel LOW, Investment Specialist, Asia, BNP Paribas Wealth Management


  • Our major asset allocation calls have worked year-to-date. Consensus expected a tough first half and better second half, while we were the opposite: overweight non-US equities since last November, overweight investment grade credit  and gold, while being underweight the USD.
  • The depth and timing of recession is key. How much will financial conditions need to tighten? The US regional banking crisis is getting worse. Watch for policy action. We remain vigilant and retain the moderate recession view.
  • What is still attractive? Non-US equities, USD diversification, structured solutions to generate better entry points, income, hedging, and finally the continued case for quality income.

Incoming recession?

Recent growth and inflation measures are better than expected overall in Europe and the US. The Federal Reserve now faces a dilemma on the back of low unemployment and still persistent inflation. How much will monetary policy need to tighten to raise unemployment and bring inflation durably to 2%? At the same time, the regional banking crisis is worsening. What can authorities do? For example, a program such as the TLGP or temporary liquidity guarantee program implemented in October 2008, could guarantee non-interest business transaction accounts such as checking accounts. This could balance moral hazard issues and lower the risk of bank runs. Assessing the impact on bank lending several quarters from now will also be key. That recession call can move to later this year or even early next year. The key now will be how much financial conditions need to tighten, generating either a moderate or deeper recession. We are in the moderate recession camp but remain vigilant.

Our Asset Allocation Calls Worked!

The consensus was for a tough first half of 2023, and better second half. We were the opposite: overweight non-US equities since last November, including Europe which was contrarian as most market forecasters stayed cautious on equities. 

Year-to-date (YTD, as of end April 2023) returns are as follows: Europe - Euro Stoxx 50 equities up +16.1%, Japan - Nikkei +11.7%, and China up +2.7% after a strong end of 2022. Furthermore, we are also overweight investment grade credit (YTD +4%) and gold (YTD +9%), while being underweight the USD. All these key asset allocation calls paid off.

Recession Proof the Portfolio

(1) Maintain Overweight on Non-US Equities: Top up China and Japan equities

In this regard, given our recommendations on Europe and UK equities are now at all-time highs, we would also highlight the recent weakness in China equites.

  • Growth: China's economy is gathering speed, with year-on-year GDP up by 4.5% in the first quarter of 2023, retail sales experiencing the highest level of growth since June 2021 and total social financing better than expected. The government is now focused on achieving a 5% GDP growth target for 2023, and hence, there is a likelihood for more policy measures to be announced, such as a stimulus targeted at the property and consumer sectors.
  • Opportunity: Chinese equities pulled back further in March 2023 on geopolitical jitters, weakness in manufacturing and further profit taking after the rally at the start of the year. The domestic A-share market could be more immune to the banking turmoil in the short term. Once the dust settles, we expect outperformance of broad-based Chinese markets (onshore and offshore).

Japan Land of the Rising Return on Equity (ROE)? Japanese equities starting to outperform. Why?

  • Reopening:  Japan is reopening this year. Recent entry restrictions have been lifted signaling a further pickup in in-bound tourism. Chinese visitors were once more than 1/3rd of total visitors. Japan is leveraged to Asia trade as well.
  • Valuation: Japanese equities remain reasonable with Topix on a forward Price-to-Earnings ratio (P/E) of 12.9x.
  • With a looming recession in the US, Japanese companies are healthy with 50% of corporates in Topix1000 having more cash than debt.
  • Shareholder friendly behavior with a record 9.2 trillion yen in buybacks in 2022. Also, ROE has gradually increased from below 7% in 2012 to over 9% in 2022.
  • Positioning: Average investor portfolio is underweight Japan. Foreign investors have been sellers of 10 trillion yen in Japanese equities since 2020.
  • Monetary policy: Latest comments from new Bank of Japan (BOJ) governor Ueda hinted at keeping in place Yield Curve Control (YCC) for up to a year. Longer-term, we would expect a gradual shift in policy given the impact on Yen and USD investments. Important to note: longer-term, the P/E of the stock market is positively correlated to bond yields including of course the financial sector.

(2) Diversify Dollar Exposure

We went underweight USD after it hit 20-year highs last September. It has since dropped 11%. While the USD may need to consolidate recent gains, on a 12-month basis, we still see further weakness. Hence, utilise near term USD strength, which will gradually fade.  


  • Safe Haven Status Waning: The USD’s safe haven status led to strong flows last year. This is less important given Europe’s warmer winter and refilling of gas storage as well as China’s reopening.
  • Positioning: International investors are structurally overweight in US equities after its massive 10-year outperformance. The US is more than 60% of global market cap, while it is 24% of global GDP. While the US is a center of innovation, “US exceptionalism” may not be as strong in the next 10 years. For example, flows to European equities are improving. Portfolio asset flows to non-US equities can weaken the dollar over time.
  • Peaking inflation and narrowing yield differential means that after the May 2023 Federal Reserve meeting hike, the Fed is at or near the peak rates, which should lower risk premiums and the USD over time.
  • Reserve diversification is happening and the main beneficiary is gold with a target of $1950 to $2150. Central banks are buying more gold than any period since 1950 and account for 33% of monthly demand recently. We remain positive after recent gains expecting some consolidation. Gold is a safe haven, diversifier in times of recession, and benefits from a weakening dollar.

(3) Add Investment Grade Bond Exposure with Higher Yields?

While we tactically took profits on our overweight government bonds after yields dropped following SVB news in March 2023, we remain overweight investment grade bonds.

  • While we expect the Federal reserve to be on hold longer than the market is currently pricing, once again we remind investors that there is reinvestment risk in deposits. Already, deposit rates have dropped in the past months.  
  • With a possible recession, investors no longer need to reach for yield and investment grade bonds will have lower default rates while being more defensive in downturns. Investment grade bond yields are the highest in a decade.
  • The corporate investment grade yield curve is relatively flat vs. the inversion on the treasury yield curve. Hence the Investment Grade curve is positively sloped from 3 to 20 years, so investors are paid to take on more duration risk.

(4) Monetise Volatility and Hedge?

Missed our contrarian calls on the equity rally? One can monetize the volatility via structured solutions in favoured names, allowing better entry points and income. Volatility = Opportunity.

In addition, if one is already overweight equities, they can take advantage of low index volatility (S&P 500 volatility below 17) to hedge market risk while maintaining portfolio exposure.


Our favoured allocations include

(1) Non-US vs. US equities, in particular presently China due to its recent pullback and Japan, after large outperformance in Europe (for which we are still overweight).

(2) Dollar diversification while expecting some short-term consolidation or rise in the dollar. The position remains on a medium term basis and dollar strength should fade.

(3) Gold remains the ideal diversifier as well to buy on pullbacks.

(4) Structured solutions allow portfolio flexibility to tailor positions for better entry points and income as well as hedging. and

(5) Quality income via investment grade bonds remain an attractive allocation.