House View, January 2023
The global economy still shows a substantial output gap compared to pre-covid trends that may not be closed in 2023. By contrast, while disinflation could reappear, the increase in consumer prices could remain above pre-covid trends. With continued rate increases biting, our central scenario is for the US to enter a mild recession in H1 2023, with full-year GDP growth at -0.2%. We have a similar full-year forecast for the euro area, where the European Central Bank (ECB) could hike rates by 50 bps three times by end-May. The outlook is even more challenging for the UK, but we see further rate hikes ahead and think rate cuts are a long shot in 2023.
As it emerges somewhat chaotically from ‘zero covid’, we believe Chinese GDP growth will accelerate to 4.5% this year from 2.8% in 2022. We are pencilling in 1.5% growth for Japan in 2023, the same as last year.
Despite investor bearishness and fairly low equity exposure, we do not believe developed-market equities are out of the woods yet and therefore remain underweight stocks overall (although we are neutral Japanese and large-cap UK listed stocks). While sales growth and cash returns to investors could be bright spots, corporate margins are coming under increasing pressure, likely leading to further earnings downgrades. At the same time, we recognise that, while still relatively high, valuations have already adjusted down significantly and that poor investment sentiment can be taken as a contrarian signal.
While, along with other issues, margin compression will challenge many equity sectors, we still believe healthcare subsectors like medtech as well as consumer staple stocks could prove resilient despite fears that their relative outperformance has run too far. We continue to appreciate the capital discipline shown by energy companies and their strong returns to shareholders. The outlook remains hazy for European industrials and for the tech sector.
The fixed-income market could remain volatile in the coming months, especially as major central banks continue to tighten policy. However, we expect monetary policy to stabilise by the end of H1. Long-term US bond yields could follow a similar path as the year goes on, or even decline as market participants price in lower policy rates. In these circumstances, and with recession looming, we are increasingly well-disposed towards 10-year US Treasuries. But a big rise in bond issuance next year even as the ECB pulls back from bond buying means we are less enthused by euro area bonds, especially on the periphery.
We believe high-yield bonds could be challenged by economic downturn in the early part of 2023, leading to spread widening and a rise in defaults. While underweight noninvestment grade bonds, we are overweight investment-grade ones, which offer attractive coupons without the need to take on too much duration or credit risk.
Two developments at end-2022 — China’s rapid unwinding of its ‘zero covid’ policy and the Bank of Japan’s surprise loosening of its yield-curve control — may weaken the medium-term outlook for the US dollar. And in Europe, the ECB’s recent hawkishness has been taking markets aback more than the Federal Reserve version.
Energy commodities had a roller-coaster ride in 2022, but at the end of December Brent oil prices were only slightly higher than at the start of the year. We expect commodities in general to regain traction in H2 23 as long as western economies recover from a shallow recession in the early part of the year and the Chinese economy fully re-opens.
Private real estate
While conditions have grown tougher in recent months, we continue to see long-term opportunities in commercial subsectors such as logistics, high-end hotels and buildings that meet increasingly stringent environmental standards, as well as in distressed assets.
Chinese re-opening could prove a boon for Asian equities, especially in northern Asia. It may be too early to bet on a meaningful rebound in Korea and Taiwan just yet, but their time could come. A wilting US dollar could also boost stocks in emerging Asia later in 2023. Local-currency Asian government bonds could benefit from similar developments. Nevertheless, the possibility that the US dollar holds up at least in the short term means we still prefer clipping the high coupons offered by Asian investment-grade bonds in USD. Chinese re-opening has contributed to a rebound for the renminbi, as well as other Asian currencies like the Korean won. However, in the short term, it remains to be seen whether these gains can be maintained in the face of a global economic downturn and the determination of western central banks to continue raising rates.
2023 Investment themes
A complex environment calls for vigilance in credit. Relatively short-duration investment-grade corporate bonds should prove more resilient to fading growth and higher default rates than noninvestment-grade issuers. De-globalisation and ‘friend-shoring’ means we like commodities and commodity-related themes, with fragmentation and dispersion pointing to further opportunities for macro hedge-fund strategies. A growing housing crunch means we see the currencies of countries where variable-rate mortgages dominate losing ground to those where fixed-rate currencies are more prevalent. We also like the currencies of emerging-market countries with credible finances. We see a convergence or equity risk premia next year, which should benefit global and US small caps and value-oriented equity markets such as Japan’s. We continue to see private assets as an essential vehicle for generating alpha. We will continue to view volatility as an asset class in its own right, using derivatives to mitigate portfolio risk and enhance yield.