The big risk fund managers are braced for in 2023

If this scenario plays out, 2023 could be another tough year for investors to make money. 

Most professional investors are fearful that stagflation will take hold next year, which would be a major headwind for both stocks and bonds.

According to the latest monthly Bank of America survey, which polled 272 fund managers who collectively oversee $790 billion (£665 billion), 92% predict that stagflation will occur in 2023. Stagflation happens when there’s slow economic growth at the same time as high inflation. Its last prolonged appearance in the UK was in the 1970s.

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Stagflation is bad news for both equities and bonds. Although, as ever, there will be both winners and losers in the respective asset class. Our recent feature on stagflation explained how investors can protect portfolios.

The expectation of stagflation reflects the bearish sentiment among the pros. Cash levels are close to record highs, at 6.2%, down slightly from last month's 6.3%, which was the highest since April 2001. This is well above the long-term average of 4.9%. 

Poor sentiment over the economic outlook is central to investor pessimism. Three in four pros expect a recession to occur within the next 12 months. 

Inflation is expected to fall, but remain “above trend” and higher than the 2% targets set by central banks.

Inflation remaining elevated was voted the biggest “tail risk” for markets (accounting for 32%), ahead of geopolitics worsening, central banks staying hawkish, and a deep global recession, which each took an 18% share of the vote.

• What is stagflation and how can investors protect portfolios? 
• Why bonds are back as a diversifier despite rate rises
• The pandemic fund and investment trust winners that have crashed 

The most-crowded trade among the pros for the fifth month in a row is betting on further strength for the US dollar, at 58%. This is followed by being short (betting against) Chinese shares and investing in oil shares, which respectfully polled 13% and 10%. 

In terms of where the pros are putting their cash, energy and healthcare stocks remain in demand.

Compared to the past decade, investors are holding more than usual in cash, defensives (utilities, consumer staples, healthcare), and bonds. Meanwhile, investors are bearish on equities, technology, European stocks, and cyclicals.