Quarterly investment outlook - Q1 2023

The last quarter of the year saw some relief for investors who had been hit from all sides throughout 2022 as markets rallied on the belief that the economy was perhaps showing enough signs of stress to persuade central banks to consider slowing and then stopping interest rate rises. Central banks, for their part, remain consistent in their messaging that markets may be overoptimistic.

Nonetheless, global equities rose by more than 7.5% in the fourth quarter, albeit for UK based investors this return was tempered due to the effect of Sterling’s appreciation against the US Dollar after the Government displayed more fiscal prudence in its latest budget. Better forecast public finances also caused gilt yields to fall meaning a positive return for investors, while gold also rallied.

Received wisdom is that markets front run economies, i.e. stock markets will sell off before economic difficulties show up either in statistics or the real world. By the same token, once evidence of a recession materialises, markets can again be looking ahead to easier monetary policy and a recovery in corporate earnings (save for those companies that might have fallen by the wayside during the contraction). Thus, the three key questions for the moment are;

  1. Will western economies officially enter a recession?
  2. If so, have markets already sold off enough to compensate for loss of corporate earnings?
  3. And finally, will this cause central banks to start to cut interest rates or will they still fear the spectre of lingering inflation?

As ever the questions are obvious, but the answers are more elusive. Consensus opinion, for what that is worth, is that Europe and the UK will suffer more than the US in economic terms, but that US stock markets are still perhaps a little too keenly priced despite their significant sell off last year.

The good news for economies and markets is that inflation has peaked, and the base effects of the calculation mean that we can reasonably expect a rapid fall in the headline inflation rates during the first half of the year. This though does not necessarily mean that inflation will fall back to the low levels that we have been used to for the past few decades, and it ought to be remembered that the 2% target that the Bank of England set is a fairly arbitrary number.

Many elements continue to impact the inflationary outlook as the world settles into a post pandemic order with much changed geo-politics. The reopening of the Chinese economy will change the dynamic again with boosts for both supply and demand sides of the inflation equation, whilst the situation in Ukraine continues to force a remodelling of energy supply chains, and manufacturers choose to manage production risks by shifting supply chains to alternative emerging markets.

Debt levels in all areas of the economy, government, corporate, and consumer, will continue to be a significant factor for future growth prospects. Governments, having dug deep to cover the pandemic stresses and now the energy crisis find themselves fiscally constrained. Some companies will experience the pain of having to refinance debt at higher interest rates, whilst the same is true for homeowners and new buyers who face rising costs and falling house values. For debtholders whose income can keep pace, a period of above average inflation may not be entirely negative.

David Baker – Chief Investment Officer

The age of disruption

We have often said that pandemics change the world in ways that we can’t calculate.

Pandemics are hugely disruptive events. Previous trends (good or bad) that are either weak or running below the radar, are reinforced and become dominant, as resistance from the status quo is diminished. Our analysis must adapt. We are most vulnerable to mistakes at a time when, even if we recognise that the world has profoundly changed, we try to analyse it with the eyes of the past, simply because these are the only tools available to us. 

Instead of trying to forecast with the eyes of the past, we need to acknowledge how the present has changed and develop the right tools to analyse the future properly.

Read our outlook for investors and business leaders

Our investment outlook for 2023

2022 was an annus horribilis for diversified portfolios. Resurgent inflation caused a very rapid unwind of 14 years of ultra-accommodative central bank policies. Global bonds re-rated at the fastest pace since 1966. It was the first time in 53 years that a significant global equity correction was coupled with a global bond market correction.

The unwind started with the fast U-turn in the thinking of the US central bank, who, in the space of a few months, went from being ultra-accommodative and treating inflation as ‘transient’, to initiating the second fastest rate hike cycle since 1976. The end of the year finds investors filled with uncertainty, as they struggle to come to terms with the paradigm shift.

Equity valuations are much lower than average, especially for non-US equities, while bond yields are at their highest levels in years, despite yield curves remaining inverted.

Read our thoughts for 2023

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