House View, December 2022
Global economy: Leading economic indicators point to a mild recession in western countries in the early part of 2023, followed by a rebound in the second half of the year. Our central forecast for global GDP growth in 2023 is 2.5%, down from 3% in 20022. We equally expect global inflation to decline next year—from 6.9% to 3.2%.
Central banks: While we believe Fed rate cuts are unlikely next year, we think the Fed funds rate will stabilise at a terminal rate of 5/5.25% by March 2023, when we think the European Central Bank’s deposit rate will have reached 2.5%. Along with the appointment of a new governor next April, we could see some adjustments to the Bank of Japan’s yield-curve control (but without outright tightening).
Major economies: We believe the rapid pace of rate hikes this year will catch up with the US economy in 2023, resulting in a -0.2% decline in annual GDP. We expect a similar decline in the euro area, with Germany and Italy the most affected by ongoing energy concerns. We believe the UK will face a grimmer time than either the euro area or the US, with GDP set to fall 1.6% in 2023. We also expect annual inflation to decelerate on both sides of the Atlantic (with consumer price inflation halving to 4% in the US next year). We believe China’s GDP growth could accelerate to 4.5% next year (from 3.2% in 2022), although we are aware of the risk of a chaotic exit from the country’s ‘zero covid’ policy. We believe the moderate recovery in Japan will continue, with GDP growing 1.5% in 2023, the same as in 2023. Elsewhere in Asia, we expect India’s economy to grow by 6% and ASEAN countries to continue to benefit from global supply-chain relocations.
Equities: While we believe we could continue to see revenue growth next year, pressure on margins may mean that earnings per share turns negative for quoted companies in developed markets. We believe pressure on valuations will be more of an issue for US equities than euro area ones, but we remain underweight both places. Sector wise, we think energy-related stocks will remain attractive and that healthcare stocks (big pharma and life science) will prove resilient in a mild recession. We also like select industrials stocks. Equity-market equities continue to face near-term challenges, but Chinese post-covid re-opening, together with a global recovery in the second half of 2023 and US dollar weakening US could give them a boost.
Fixed income: As inflation slows and recession looms, we believe longer-dated US Treasuries will again be seen as safe havens. We have moved from a neutral position on US Treasuries overall to an overweight one. But we are more neutral on core euro area bonds in view of Europe’s greater energy vulnerability and large-scale fiscal stimulus in Germany. In corporate bonds, we remain cautious about prospects for noninvestment-grade credits given many issuers’ exposure to floating-rate debt and the chance we will see a rise in default rates. We are neutral on short-to-medium term US and European investment-grade credits, which offer appealing coupon for lesser risk. We also continue to like investment-grade Asian credits in USD, believing that spreads will tighten if the Chinese economy regains momentum.
Commodities, currencies: Weakness in oil demand is likely to be met with production cuts, thus placing a floor under oil prices in the coming months. In H2 2023, the recovery in western economies and Chinese re-opening could boost oil prices, especially in the context of limited spare production capacity. As for currencies, we believe the overvalued US dollar may have peaked, although it could experience ups and downs in the short term.
2023 investment themes: We believe we could see a revival in 60/40 portfolio strategies next year, with government bonds coming into their own again as recession looms and rate rises tail off. Overall, we think that the bond vigilantes are back, meaning that policy missteps will be quickly punished. In corporate credit this means adopting an active, vigilant approach. This is why we continue to prefer short-term investment-grade bonds over noninvestment-grade bonds and prefer companies with fixed-rate loans over those with floating-rate debt. We also prefer the currencies of countries where fixed-rate mortgages are more prevalent to currencies where variable-rate mortgages dominate. In equities, we believe a convergence of risk premia will shake up the opportunity set, to the benefit of global and US small caps as well as Japanese stocks. We continue to like commodities and commodity-related themes as well as industrial firms set to benefit from well-targeted capex spending. And dispersion and fragmentation mean we still like macro hedge-fund strategies. We believe that private assets will be more essential than ever to generate alpha and see recent drops in valuations as offering good entry points into private equity and private real estate for investors with long-term investment horizons. Finally, we believe volatility should continue to be treated as an asset class in its own right. This means using various option strategies to avail of tactical opportunities and mitigate portfolio risk.