At a time of year when we tend to wonder if--and hope that--the year ahead will be better than the year behind us, the economists at Quintet are not playing the comfort card. They have said that there will be little reason to rejoice at midnight on 31 December.
“Against a backdrop of war in Ukraine and energy shortages, the eurozone and the UK will be in recession during a cold, dark winter. In the US, where consumer and business activity is stronger, recession also looms, but it will be milder. At the same time, China will continue to slowly but surely reopen its doors, thus avoiding a global recession. But high global inflation, although falling, will probably still remain above central bank targets in 2023 and 2024,” they stated. Daniele Antonucci, chief economist, and Nicolas Sopel, senior macro strategist, at Quintet Private Bank, estimate inflation at around 6.7%, compared with 9% in 2022.
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So that’s the background. “However, as the seasons go by, the markets will adjust to new emerging trends. Indeed, the coming year will be divided in two: from spring onwards, central banks will stop raising interest rates, inflation will visibly decline and a new global growth cycle will begin, thanks in particular to accelerating Chinese growth. But the recovery will be uneven, with Europe and the UK lagging behind the US, and developed markets growing much more slowly than emerging markets,” the two economists stated.
How can investors deal with these new trends?
Firstly, by diversifying their portfolios, taking advantage of the fact that the phase of very close correlation between stocks and bonds of recent years is coming to an end and that bonds are once again, with reservations, an attractive asset class.
US inflation has probably already peaked and the next rate hikes will be smaller than in recent times
“Equity and bond prices have fallen simultaneously this year, creating significant diversification challenges. While volatility may remain high in 2023, high-quality bond markets--and government bonds in particular-- should again offer defensive benefits, reducing portfolio risk,” said Antonucci. For him, US Treasuries look attractive for next year, “because US inflation has probably already peaked and the next rate hikes will be less significant than recently. These rate hikes should even stop at the end of the first quarter or the beginning of the second quarter.
"While the macro outlook is much less rosy in the eurozone and the UK, government and investment grade bond spreads there look increasingly attractive as inflation approaches its peak. Emerging market hard currency sovereign bonds have suffered in 2022, but valuations are now attractive, particularly relative to US high yield,” he said.
We remain convinced that eurozone equities have not yet fully priced in the deteriorating economic conditions
On the equity markets, Nicolas Sopel advises caution. He said that this is not the time for investors to “re-risk” or “de-risk” their portfolios. “Rather than injecting their capital into or out of the equity markets, long-term cautious investors will be watching carefully for catalysts such as changes in the Ukraine conflict, inflation trends and China, where the zero-covid policy and tensions with Taiwan continue to be high on the list of risks for 2023.”
Given the environment, he favours high dividend, low volatility stocks.
In terms of geographic allocation, Sopel favours US stocks over European stocks. “Although this has been one of the worst years for US equities since the mid-1970s, valuations remain high in relative terms. Nevertheless, we believe this is a price worth paying for exposure to this particular market of such high quality stocks, especially as the pressure of recession mounts. At the same time, we remain convinced that eurozone equities have not yet fully priced in the deteriorating economic conditions. In comparison, emerging market valuations look attractive. We expect China to reopen and stimulate its economy in 2023, supporting emerging markets, which will get a further boost from a slightly weaker US dollar.”
In the currency market, Sopel believes that the dollar will weaken as recession fears ease, inflationary pressure diminishes and the US Federal Reserve begins to take a more moderate stance. “Outright rate cuts are unlikely in 2023. However, balance sheet reduction is likely to continue.”
Sopel stated: “The European Central Bank and the Bank of England are likely to follow in the Fed’s footsteps. The recovery of the euro and the pound should therefore be insignificant.”
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