How to build your investment portfolio amid uncertainty in the financial system

Central banks are finding themselves in a challenging position as they navigate a high stubborn inflation environment and fears over a fragile banking system, particularly in the US. In a recent interview with Izak Odendaal, Investment Strategist at Old Mutual Wealth, the discussion revolved around how and where to build investment portfolios in such a volatile climate. Odendaal highlighted the fading of the recent banking panic episode, attributing it to strong interventions from central banks in providing liquidity to financial institutions. However, he noted that short-term and long-term uncertainties still loom. In the short term, central banks continue to raise interest rates to combat inflation, potentially impacting banks that were previously troubled by interest rate exposure. Furthermore, there are concerns about banks becoming more cautious, leading to a reduction in lending activities that could slow down the economy. Odendaal mentioned that this cautious approach by banks could inadvertently align with central banks' goals of economic slowdown. However, he also warned of the risk of over-contraction in the banking sector, which could negatively impact the US economy. The discussion also touched upon the dilemma between the Fed's rate hikes and banks' lending contractions, potentially creating an environment of over-tightening. As smaller banks raise interest rates to retain deposits, the economy faces the risk of excessive tightening. While the acute phase of the financial panic may have passed, a more chronic phase lies ahead as banks navigate restructuring and balance sheet adjustments to adapt to the new environment. Central banks, including the Fed, are expected to proceed with caution, considering the broader implications beyond inflation. Odendaal suggested that while the equity market in the US signals a soft landing, the bond market's inverted yield curve indicates recession risks. He favored the bond market's perspective and recommended increasing bond exposure within the US while looking to diversify equity risk outside the country. For international investments, Europe emerged as a potentially attractive destination due to better pricing and valuation metrics compared to emerging markets. Amid lingering uncertainties, Odendaal advised against overweighting equities in the current climate, emphasizing the need for a balanced and diversified approach to investment portfolios.