Despite the strength of the markets, we expect economic growth to slow down in 2023. Recessions in the United States and Europe are expected, but we expect inflation to be contained thanks to a record tightening cycle by central banks throughout the world. China and Latin America will continue to face growth obstacles.
In light of the current macroeconomic environment, we believe that a concentration on core fixed income will serve as a strong portfolio buffer. Generally speaking, we choose high-quality, cash-generating stocks among those traded on public exchanges.
However, we do see a way to a better economic outcome, which might result in better-than-expected performance for risk assets like stocks and high yield bonds. This improved state of affairs is possible because to a trifecta of factors:
- A low rate of inflation
- Sturdy firms and consumers
- Instances of “white swans” that occur on a global scale (i.e., positive geopolitical developments that would improve investor sentiment)
In this article, we’ll examine the forecast for the United States.
No harm will come from inflation, thankfully
There are several indications that the inflationary peak has already occurred. The costs of both imported items and raw materials used by manufacturers are falling at a fast rate. The price of crude oil and gasoline in the United States is at an all-time low.
The most current statistics from the U.S. Consumer Price Index indicated that core inflation increased by 20 basis points from the previous month, the weakest rate of the year. Despite the fact that private data indicates a considerable slowing in market rent rises in real time, shelter inflation, which accounted for most of that shift, lags behind the private data.
Expenditure growth for rentals expected to slow down
Importantly, this slowing inflation has corresponded with a rather modest rebalance of the labor market. Both the pace at which people are leaving their jobs and the rate at which new ones are being created have decreased from their peaks, suggesting that labor demand is weakening. According to the latest numbers from non-farm payrolls, however, hiring is continuing at a healthy clip of between 250,000 and 300,000. The unemployment rate, which is closely monitored, is now quite low.
In summary, if inflation keeps decreasing at a quicker pace than the labor market worsens, a “soft landing” for the economy may be conceivable.
Markets and companies that can bounce back
Real estate and finance, two industries sensitive to interest rate changes, and firms that grew rapidly to fulfill temporary demand during the epidemic are the only ones to have felt the effects of the economy’s shakiness thus far.
The U.S. economy seems to be doing rather well. As inflation moderates and real incomes rise, consumers may choose to increase their spending somewhat.
The increased cost of getting a mortgage in the United States has effectively halted any potentially lucrative side businesses. Despite the increase in interest rates, the real cost of borrowing for many consumers has remained unchanged since more than 90% of new mortgages are fixed. While the quits rate may have peaked, it nevertheless indicates that employees are optimistic about their career prospects.
Companies seem to be in control of their debt levels due to their ability to lock in historically low interest rates. In spite of higher inflation and salaries, profit margins have held up quite well. Businesses in 2022 had challenges in adapting to changes in consumer purchasing. At the height of the COVID-19 pandemic, demand for commodities and clothing plummeted in comparison to demand for face-to-face services, which were generally shut down.
Businesses have, on the whole, adapted rather effectively. And it’s possible that inventory and price fluctuations may grow less extreme in the following months and quarters.
Profit margins have been more stable than anticipated despite increases in inflation and salaries.
The confidence CEOs need to borrow money for investments in new factories or acquisitions may come if monetary policy tightening slows down (or even stops). It’s possible that consumers and companies may adjust to a rising interest rate environment better than many anticipate.
Ukraine and China: Global White Swans
The conflict in Ukraine, the real estate slump in China, and the COVID lockdowns have all thrown a shadow over global economic and financial prospects. Additionally, they have contributed to a substantially stronger U.S. currency, which acts as a drag on global economic expansion.
The dollar would undoubtedly weaken if there were any progress made on any of these fronts, which would reduce economic friction throughout the world. Moreover, improved market sentiment would result from the shift.
The dollar seems to be significantly overpriced.
Even if a deal is reached between Russia and Ukraine, it might take years for Europe to make the necessary adjustments to its energy infrastructure.
Given the present pessimistic mindset and investors’ limited exposure to Chinese markets, a policy shift toward reopening the Chinese economy, accepting Western mRNA vaccinations, expanding the property industry, or providing more market-friendly language might stimulate markets.
Resulting Implications for Capital Expenditures
An inflation conclusion that is benign, resilient consumers and companies, and global white swans might all have significant effects on the market. Risk assets (like equities and high yield bonds) may end up doing better than “safe havens” (like core fixed income or gold) as a result.
It’s conceivable that the value of the dollar in the United States would fall much more. There’s a chance that European and Chinese markets may lead a global equity rise. Given their lower valuations and greater susceptibility to economic development, small and mid-cap U.S. firms might easily beat big caps.
Lower inflation and a less aggressive approach from central banks would likely lead to lower rates and respectable performance from investment-grade fixed income, even if core bonds would likely lag risk assets.
Consequently, although our baseline forecast for 2023 predicts slowing growth around the globe, we have learnt from the last three years to be prepared for anything. For 2023, a prosperous conclusion economically is a must.