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Policymakers, at least in the U.S. and Europe, now appear resigned to weaker economic growth in 2023. Any recessions are likely to be short-lived, but they will not be painless. The combination of lower growth, lingering inflation and public spending constraints will be difficult for both people and governments. Social inequality will be a topic of immediate and growing importance.
Slower economic growth in 2023 will not necessarily translate into weaker financial markets, however. In fact, markets could prove more resilient in the coming year than they have been in 2022.
Market volatility in 2022 has been exacerbated by external events and changing expectations around the likely size and speed of monetary policy tightening, in the face of high and persistent inflation. Central banks have struggled to give consistent forward guidance. Confusion in markets has driven sharp swings in bond yields, also destabilising equity markets.
Central banks and investors are likely to find 2023 rather easier. We forecast that inflation will ease down (but stay well above central bank target levels). We hope that major global setbacks (from geopolitics, disease or other factors) can be avoided. As a result, although more central bank rate hikes are in prospect, increases in longer-term government bond yields should be relatively modest from here on. The worst should now be over. For bond investors, yield and quality will no longer be a contradiction.
More stable bond markets should, in turn, help lower equity market volatility. 2023 is likely to
be an acceptable year for equities, but not a great one. Positive returns will be driven by some modest price/earnings expansion and dividends – but earnings per share will be stagnant. In this calmer environment, relative regional valuations may become more important.
2023 could also see a more stable USD with the Fed’s likely future hiking programme probably now sufficiently priced in. In fact, the EUR could strengthen slightly over the course of the year, given our expectation that inflation will come down more slowly in the Eurozone than in the U.S.
Of course, next year will not just be about inflation and monetary policy tightening. China, for example, will be following a rather different policy path. We think that continued domestic stimulus will eventually succeed in turning its economy around. Chinese recovery, combined with regional reopening, means that Asia could have a good 2023.
An overarching concern, with major investment implications, will be the environment. Limiting global temperature rises to 1.5 Celsius will involve major structural changes to the way we live. Investors should anticipate these changes and can, via ESG investment, help facilitate some of them. We highlight two of our long-term investment themes in this annual outlook: the energy transition (to greener sources of power) and infrastructure. These, and our other seven long-term investment themes (also discussed), are likely to provide major investment opportunities in the years ahead.
Portfolio management in 2023 needs to plan for this. All investors should consider the following three factors.
First, easing but continued inflation. Consider possible partial hedges against this in terms of asset classes (e.g. equities) or themes and sectors (e.g. some infrastructure).
Second, generally modest but positive return expectations. We forecast mid-single digit equity returns, for example. Investors seeking higher returns may want to look to alternative investments in private markets.
Third, risk. Despite our expectations of more stable financial markets in 2023, the world remains intrinsically risky. Prior thinking about potential financial implications can help protect portfolios.
I wish you a successful investing year. We are always here to assist.
Christian Nolting
Global CIO
