As investors near the end of one of the most turbulent years in history, jarred sullivan He reflects on the roller coaster that was 2022 and delves into our expectations for financial markets in 2023.
As investors near the end of one of the most turbulent years in history, we reflect on the roller coaster that was 2022 and take a deeper look at our expectations for financial markets going into 2023.
Bonds and stocks posted low returns in 2022, providing very little diversification benefit amid a highly uncertain investment environment. The war between Russia and Ukraine, a higher-than-expected global inflation trajectory, a sea change in monetary policy communication, the China lockdowns and the slowdown in global economic data are among the main reasons for the operating environment without precedents.
stemming the tide of inflation
Right now, investor attention is focused almost entirely on the US Federal Reserve’s (Fed) monetary policy outlook to determine how quickly the world’s largest central bank can stifle the trajectory of inflation. The resulting impact on economic growth and company earnings will likely determine the direction of asset classes going forward.
At the Federal Open Market Committee (FOMC) meeting in September, the latest forecast material was released. Inflation forecasts for personal consumption spending were raised again throughout the projection horizon and are projected for this year at 5.4% compared to 5.2% previously. Gross domestic product (GDP) estimates were cut to just 0.2% this year from 1.7% previously. More importantly though, FOMC members raised their dot plot projections to 2023, their key short-term interest rate projections. This is despite federal funds futures market pricing in interest rate cuts next year amid concerns about economic growth transitioning to a below-trend state. These factors are likely to make it difficult to generate returns in both stocks and bonds, with the former already enduring a significant downgrade so far this year, meaning investors want to pay less for stocks per unit of earnings. . Meanwhile, the latter has been at the mercy of the Fed raising the global cost of capital, resulting in an unprecedented global appreciation in government bond yields.
Repressed economic activity?
Our main concern for the coming year is whether the company’s earnings resilience can be extrapolated into the future. We believe this may prove difficult as fiscal and monetary policy, particularly in the US, will likely follow a tighter path. In particular, the lagged effect of monetary policy tightening will likely start to filter through changes in consumer behavior. Higher borrowing costs for both businesses and consumers are likely to suppress economic activity, particularly in areas related to discretion, as economic agents seek to control spending to adjust their balance sheets and income statements.
Based on the latest available data, US real average hourly earnings sit at -2.8% yoy as of end-October 2022. This marks as one of the lowest readings on record as inflation continues eroding the purchasing power of consumers. . Similarly, savings rates have plummeted to just 3.1% as of end-September 2022, levels comparable to the 2008 global financial crisis, as consumers continue to draw on reserves to cover income shortfalls. . Additionally, households are using various credit instruments to prop up spending in the short term, particularly credit card debt which is currently reaching all-time highs.
These dynamics, combined with a rapid withdrawal of liquidity, are certainly not sustainable and point to an increasing likelihood of a hard landing in the global economy as we head into the new year. In the absence of supply-side reform by the US government, particularly in the energy sector, moderating economic demand is likely to be the only way to bring inflation back to the Federal Reserve’s desired target of February 2. %.
housing market slowdown
The developed world property market is showing signs of slowing down, especially looking at UK and US mortgage application and approval data. However, it will take time to filter through any meaningful price moderation of the house. This will also be particularly important in the context of US Federal Reserve policy, given that the housing market accounts for roughly a third of the Consumer Price Index (CPI) basket. However, Fed Chairman Jerome Powell acknowledged that activity has moderated of late and has said active selling of mortgage-backed securities is unlikely in the near future.
Growth expectations hampered
While the Eurozone Central Bank and the Bank of England intend to raise interest rates much higher to control inflation, the Bank of Japan (BoJ) continues to diverge. The BoJ’s reaffirmation of its commitment to accommodative monetary policy has put enormous pressure on the Japanese yen. A supply shock in the natural gas and soft commodities markets, fueled by the war between Russia and Ukraine, has severely hampered growth expectations, especially in the UK and Europe. Consequently, corporate margins and household income statements in these regions will likely be negatively affected.
On the emerging markets front, China continues to show mixed signals by easing monetary policy amid well-contained inflation levels, while lockdowns continue to impede a sustainable recovery in economic growth. At this stage, we remain cautious, although valuations look cheap, and expect opportunities to emerge in the coming months.
reduce risk
We are heading into a new year in which we currently believe that the company’s economic growth and earnings expectations are overly optimistic. We prefer sectors with less earnings cyclicality which are therefore less vulnerable to sporadic changes in the business cycle. We also have a strong bias towards the US dollar which tends to benefit from both tightening global financial conditions and risk aversion events, when traders and investors reduce their risk exposure. The countercyclical nature of the greenback counteracts economic fluctuations and therefore offers better risk-adjusted returns relative to other asset classes during times of heightened uncertainty in the global economy. At this juncture, we prefer to take less risk.
On the fixed income side, we maintain our underweight duration position amid tighter monetary policy dynamics due to high levels of inflation. However, once market participants have sufficiently priced in the Fed’s hawkish top and inflation is firmly on a downward trajectory, we will look to take a more explicit position on the long end of the curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears.
Given the persistent positive correlation between stocks and bonds, we believe raising cash is key right now.
Jarred Sullivan, global multi-asset investment strategist at Ashburton Investments. News24 encourages freedom of expression and the expression of diverse points of view. Therefore, the opinions of the columnists published in News24 are their own and do not necessarily represent the views of News24. News24 is not responsible for investment decisions made on the advice of independent financial service providers. Under the ECT Law and to the fullest extent possible under applicable law, News24 disclaims all liability for any damages resulting from the use of this site in any way.
