Q&A: 2023 and beyond – rates, recession and returns

Q&A January 2023

• Last year we spoke about the return of inflation – the extent of which probably surprised everyone. There’s been a lot said about the central bank responses so far, but how do you see monetary policy panning out for the rest of this year, especially if the anticipated recession materialises?

  AP: Monetary policy has been as restrictive in tightening as it was loose when the fed tried to support the economy following Covid-19. That, combined with the 27.62% increase in the trade-weighted dollar since December 2021 will see inflation surprise on the downside in the coming months. The Fed therefore will have likely tightened to 4.75% after February 2023’s meeting and this will probably be an overkill given that inflation will be falling rapidly – this will give the Fed pause and if we see weaker wage inflation this year, we could see rates starting to come down even without a recession.

  BK: Not everyone was surprised. Those who understand that inflation is a monetary phenomenon were not surprised, given the enormous increase in the money supply post the lockdowns. Nor have they been surprised by the end of inflation in the US since June, given the abrupt reversal of money supply growth. M2 money supply has been flat since January last year and the consumer price index (CPI) was no higher in December than it was in June when headline annual inflation was 9.7%. It is now 6.5% and heading for zero before the end of 2023.

  The Fed has still to be convinced that inflation is down and out. But it too cannot continue to ignore the fact that demand in the US is stagnant and that demand-led inflation is over for now. A recession has become likely and the Fed will soon have to tilt to maintaining full employment rather than chasing its tail on inflation. We will have to wait up to three months for this Damascene moment.

  JW-E: For now I am taking the Fed at its word – higher for longer. It could pivot, but only in the face of a much weaker economy and/or stress developing in credit markets. The ECB will not front-run any Fed shift. The Bank of England faces a tougher structural inflation background. China leads in the rate-cutting cycle.

  CH: I suspect we get hikes until around April – at which point the trend for inflation will be much more encouraging for the Fed and ECB and growth numbers will likely be very weak. I expect they will start to cut by September.

  ZD: While it’s widely expected that inflation will continue to fall and recent data has been supportive of this view, the reopening of China will have painful side effects in my view. This could be a floor on inflation, or worst case it could reverse the recent downward trend in inflation and central bankers will have no choice but to keep monetary policy tighter for longer. These actions would be pursued despite any risks to recession as we have witnessed in the past year how central bankers stayed true to their mandates of reining in inflation at all costs. Nonetheless, we believe the quantum and velocity of rate hikes will slow in 2023 as most inflation drivers have weakened.

  OM: The monetary policy direction should remain in line with new expectations. Developed markets are more vulnerable to persistent interest rate increases as they continue to try tame inflation. Emerging markets may have leeway to slow down their rate hikes, although upside risks for continued hiking remain, the result of persistent hikes by developed markets, which could have an impact on the relative attractiveness of emerging market debt and currency performance.

  RC: After the US Fed embarked on its fastest pace of annual rate hikes in history in response to inflation rising to 40-year highs, inflation is now rolling over.  Supply chain disruptions are fading, particularly now as China reopens and abandons its zero-Covid policy, energy prices have fallen back to levels pre the Russian invasion of Ukraine as Europe continues to navigate its way through the energy crisis, and the cost of shelter in the US declines. At the same time, financial conditions have become much more restrictive than they have been in many years and economic growth has slowed with concerns around a probable recession. This means the Fed can now slow its tightening campaign and is closer to the end, with probably another 0.75 to 1 percentage point in hikes still to come by the end of the first quarter of 2023 before going on pause for some time. I don’t see them cutting rates anytime soon or indeed this year – the US economy may prove more resilient than people currently expect, but it’s still going to take some time for inflation to fall to central banks’ target levels, the US labour market remains tight, and we need to wait and see what the lagged impacts of previous Fed tightening are.

  BS: While the central banks are talking tough, I expect they will soften their stance if a recession materialises. I think we are turning the corner on inflation in the short term, but I do expect that longer term there will be higher levels of inflation than what we have become accustomed to in the past decade.

  NU: I tend to agree with the consensus on this one – ie inflation will moderate but not to the levels of the last decade. Central banks will get back to what they should have been doing and not move rates down materially. I fear however that financial repression will be with us for some years and once we are through the next phase of this rebalancing, negative real yields will continue to be an issue. I don’t have a high degree of confidence in my base case and don’t rule out the outliers of a deflationary bust or continued high inflation.

• Based on your view, do you think they’ll get inflation back in line with pre-2022 averages, or is the genie truly out of the bottle? And what will this mean for the different asset classes?

  BK: For now inflation goes back to 2% or below and stays below if growth in money supply and bank credit do not lift off the floor. In the long run, the US fiscal deficit and the Federal debt – paying interest will take up a growing share of the Federal budget – will be a threat to the independence of the Fed. Its failure to anticipate inflation on the way up and way down, enough to threaten recession, will not be reputation enhancing. A soft landing, dependent on a reversal of short-term interest rates, would add strength to the Fed. The most obvious beneficiary of unexpectedly low inflation and weak growth will be Treasuries. I would be adding heavily to long-term Treasuries – less cash and also less weight to US equities.

  ZD: While the direction of travel for inflation has been encouraging, the world we have become accustomed to over the last four decades is no longer valid and we are entering a new paradigm of structurally elevated inflation as a result of deglobalisation and high debt levels. The deflationary power of the globalised world economy will all soon be in the rear-view mirror due to homeshoring.  Debt levels in many western economies have grown too high and could see the engineering of higher nominal GDP growth through a higher structural level of inflation to get rid of high levels of debt. The homeshoring boom will however lead to capital investment on a massive scale into the reindustrialisation of domestic economies, as such commodities will be massive beneficiaries. Equities will benefit from high levels of inflation.

  OM: The genie is out of the bottle. Inflation should come back in line with targets over the next nine to 12 months, however, there are significant risks posed for consumption, which in turn should result in less price determination by producers (lower margins) as a result of lower purchasing power on the part of consumers.

  JW-E: I believe the genie is out of the bottle, but that doesn’t mean that headline inflation cannot drop below expectations this year. But that will be a spoof. Long-term market expectations for inflation (break evens) look too low to me. So much depends on the Fed’s resolve. If they bottle it/call the all-clear, then inflation bounces back and we are into a stop/start policy. That will make balancing risk diversifiers in a portfolio a challenging task. Index-linked bonds/TIPS will help again if inflation expectations rise. If the Fed decides that 3%+ CPI inflation is acceptable, then gold could be a strong buy.

  NU: The genie is out of the bottle and inflation will be with us for some time. I don’t believe rates/inflation will return to previous decade levels. The good news though is that more asset classes offer some form of return and traditional balanced portfolios should do better. The real issue is: “Has sufficient risk premium been priced back into asset prices?” allowing for material allocations across the classes.

  RC: Inflation should continue to ease and surprise on the downside in the first half of 2023. US Core PCE will likely halve from last year’s peak level and fall to around 3% later this year but that’s still above the 2% target. However, the impact of Putin’s ongoing war on food and energy prices is a moving target. But don’t forget that we are currently getting disinflation in China with core CPI below 2% - which will be exported to other regions. Falling inflation should allow bond yields to decline or at least maintain trading around their current levels (inflation is usually bad for bonds) while slowing economic growth or recessionary concerns should benefit them. Notwithstanding last year’s rate hikes that make starting yields for bonds now more attractive, G7 bond yields are currently only around fair value. Some moderate inflation is usually good for corporate earnings and equity while historically commodities have provided a good inflation hedge. Comparatively attractive nominal yields mean that cash can be a place to hide from elevated uncertainty, but not for any prolonged period given that you are going backward in real terms and there’s an ongoing opportunity cost to holding it.

  AP: As stated above – I do feel that inflation will react to monetary policy as well as the renormalisation of fuel and food prices as well as a sharp decline in shipping prices. This will add to the down draft in the CPI number and could surprise on the downside this year.

  BS: It appears that we are seeing some meaningful improvements as supply chains disentangle and oil and gas trend lower after the Russian-induced spike last year. I do think that inflation will be slightly higher in the longer term, and this will impact the valuations of ‘long duration’ equities and bonds. Nevertheless, I think these may experience some short-term support or in the case of equities at least offset some of the potential weakness that would be caused by poor Q1 and Q2 earnings. The era of easy/free money could well be over, and this could impact speculative investments such as venture capital, crypto and other investments that require extended periods of capital expenditure or investment before they become profitable. Valuation and cash flow are going to play a far more important role and buying in hope of continuous upward revaluations and the promise of long-dated profitability are unlikely to work in the medium to longer term.

• The midterms are over in the US and we have a more “balanced” positioning between the House, Senate and White House. What will this mean for US policy (economic, social, geopolitical, environmental, etc)?

  RC: The key takeaway is a government gridlocked for the next two years with no new major legislation. The domestic policy may be paralysed by the political stalemate, competing interests and Biden’s low approval rating. The bipartisan Infrastructure Bill and the Inflation Reduction Act (no Republicans in Congress voted for it) are game-changing climate legislation, but the new composition of Congress will subject the Biden administration’s environmental efforts to greater oversight and may blunt them. Given recent developments in crypto markets, we may see new regulations for digital assets. They will probably also be able to agree on legislation that funds the federal government, deals with the debt ceiling and ultimately their jobs. But the Republicans would like to cut spending without increasing taxes so there will probably be a freeze on major fiscal policy. The Democrats will try their utmost to avoid an economic recession as that would seriously hurt their chances of retaining the White House in the 2024 election which is currently too close to call. US foreign policy which had turned more assertive and hawkish (to Russia, Iran and China) will remain supportive of traditional allies and is unlikely to see any big swings as both the parties are remarkably like one another on pressing international issues. However, foreign powers may not be willing to give concessions or make concrete deals when there’s a real risk of a new US president coming into power and reversing course.

  AP: A split government means that neither party has an open chequebook, and this will serve to keep government spending contained (always a good thing), but will mean that the economy cannot expect too much support via government spending and, given the tight monetary policy, will keep inflation in check.

  CH: More gridlock – but that’s not a bad thing for markets. The debt ceiling will likely come up again but I suspect it’s unlikely that the US government will be forced into a position that sees it selectively default on debt.

  BK: A Republican house means less spending by the Federal Government, though spending on the US military will be sustained or perhaps increased as a percentage of GDP. Government debt is a live political issue that divides the parties. House rules have changed meaningfully to give power to the right of the Republican Party.

• Do you see a resolution this year to the war in Ukraine, or will it drag on? Based on this, what are the implications for geopolitics and the world economy?

  AP: I suspect we could see an unexpected resolution to the Ukrainian war this spring – the war is not going well for President Vladimir Putin, with the Ukrainian troops having launched successful attacks on the Russian forces, killing hundreds of Russian soldiers. The US announced it would send more Patriot missiles to Ukraine, neutralising Russia’s air superiority, while there has recently been an agreement to supply tanks as well. Europe is having a very warm winter, weakening Russia’s energy leverage. Putin, reportedly in poor health, might seek a truce with Kyiv this year. A peace deal between Russia and Ukraine will crush oil prices, but global equities will benefit.

  OM: Europe has been fairly quick to pivot away from Russian energy supplies and continues to progress and hoard supplies, with storage at capacity. It is too early to determine the kind of winter Europe will have, although temperatures are now low. Persistent low temperatures may put pressure on European energy systems which could result in Russia gaining some sort of upper hand in the region. Should the energy reserves be sufficient to fend off energy disruption as a result of the cold, the Russian stranglehold over Europe would loosen significantly.

  RC: A fiercely resistant Ukraine, European energy diversification, and NATO enlargement suggest a continued grind to the war. Putin needs high oil and energy prices to be able to continue bankrolling the war. He has shown no genuine desire to back down yet and an exit that will save him face is fast disappearing. At the very least, the region will remain unstable and geopolitical risks elevated against this backdrop. The risk is that Russia meaningfully cuts oil production, causing a global oil shock that could tip an already slowing global economy into a recession. Energy security and transition (away from Russia) as well as spending on national defence is front of mind for many nations – these should provide some underpin to growth.

  CH: It does seem that the tide is turning in favour of Ukraine. It’s difficult to see how Russia can extricate itself from the war unless it comes with a change of leadership. I suspect the base case is that Russia withdraws as the war becomes prohibitively expensive but there is a sizeable tail risk (low probability, high impact event) around this.

  BS: I expect it to drag on for as long as Putin can. There doesn’t seem to be a favourable compromise for him on the table. I think there will be flare-ups from time to time but I don’t expect he will escalate to a point that would endanger his own life, given his evident fear of his mortality.

  JW-E: It will drag on. The world gradually rejigs supply chains. No big effect.

• Switching to China, the world’s second-largest economy had a troubled year in 2022. Will the jettisoning of the zero-Covid policy be good news for its economy (and the world) or are there still major underlying issues that could hold it back?

  AP: China has structural problems with its rapidly ageing population as well as a big property bubble, but similar to what we experienced in the rest of the world, the re-opening trade will be strong and this will be a boost for the European economy (and the world), as a powerful engine of growth will re-join the world market as US growth softens.

  ZD: After enforcing zero Covid in a draconian fashion and then the great U-turn without due preparation, the reopening will not be plain sailing and could see China’s economy contract in the first quarter of 2023. The worst of the wave will pass, however, as the year progresses and economic activity will rebound sharply. The strong rebound of this behemoth could alone power much of the global growth, especially benefiting commodity exporters.

  OM: It should be good news, as production increases and normal economic activity resumes. Inflation has also been tame in China with a limited risk of contagion for the Chinese consumer, therefore spending power should resume. This would be positive for luxury goods (Richemont) and Chinese retailers too.

  JW-E: A strong short-term boost to consumption (of services) is probable. The market is not positioned for China to perform well, so it will be a “pain trade” for many now. Long-term growth will have to evolve towards more productive domestic growth and so the old buy real estate/commodity trades won’t have legs.

  RC: The removal of various Covid-19 restrictions should provide result in a drawdown in savings and an improvement in consumer confidence which will boost Chinese consumer spending, especially in the services sector, which was badly hit. Large injections of liquidity in the property sector last year mean that it will no longer be a headwind to growth in 2023 but it is unlikely to be a positive contributor either. After consolidating his political power last year, President Xi looks set to ease monetary and fiscal policy this year to stabilise and ignite the economy. So, expect a better year for the Chinese economy, with GDP growth accelerating closer to the trend growth level of around 5%, and for risk assets. Declining trade will be a minor headwind as will ongoing concerns around the health of the housing market and shadow banking industry.

  CH: There are major demographic headwinds for China. Its population has started to decline and the working-age population has already been in decline for some time. But over the short term, we should probably pencil in more stimulus – and a sizeable rebound in the Chinese economy.

  BS: China appears to be reverting to a more market-friendly approach, but the damage has been done and it will take some time to restore the West’s confidence. Nevertheless, it seems best positioned to stimulate its economy and valuations are attractive.

  NU: Short and medium positive; long term I don’t see how one can confidently invest in China. Chinese assets may need to be traded more, as opposed to being long-term investment holds.

• Will relations between China and the West improve or get worse in 2023? Is there scope for a geopolitical incident?

  JW-E: Much the same. There’s an outside risk of China curtailing supplies of some commodities/goods to the West (“weaponisation of inflation”), but it can only do so much without hurting itself. Taiwan election in 2024 is a chance for China to exert control over Taiwan “peacefully”. Let’s see how that plays out before worrying about an invasion.

  CH: I expect relations between China and the west will not change materially over the coming year. More tension around trade and Taiwan but no major events.

  BS: There is always scope for a geopolitical incident, but it appears that China realises it needs better relations with the West to ensure its economy succeeds. China has become far more conscious of this post the economic damage caused by the apparent failure of numerous property developers and extended Covid lockdowns, as well as the uprisings these have sparked.

  RC: Given the material ideological differences, I cannot see relations thawing meaningfully at least not until after the US 2024 election. Fraught Chinese relations with Taiwan and various US efforts to limit Chinese encroachment on Western intellectual property suggest that ongoing tensions could easily spill over into a more serious incident.

  BK: China’s problems are of its own making – it is not nor does it aspire to be a liberal democracy and is therefore a “frenemy” to the West.  This remains a threat to global trade and the global economy.

  OM: The salient risk in China is escalating geopolitical tensions with Taiwan, leading to China invading Taiwan. Should this materialise, the effects would be as devastating as the Russian invasion of Ukraine. Global supply chains would be at risk, particularly microchips. Western-imposed sanctions would further exacerbate the situation.

  AP: China will be dealing with the re-opening as well as the number of sick people on top of several internal issues this year and I do not see them seeking to change the external situation. When the re-opening momentum in growth slows in 2024, this will force/allow China to focus externally to find a way to draw domestic focus away from internal malaise. Therefore, from the Chinese side, I only expect geopolitical risk to increase post-2023.

• Based on all of the above, what are the implications for the different asset classes – equities, bonds, currencies and commodities?

  RC: There is still significant uncertainty around the economic growth outlook and monetary policy. Where markets end up at the end of this year will largely depend on three Rs – where and when the Fed funds rate peaks, the extent of any recession, and earnings revisions. The MSCI World 12-month forward PE multiple is fair to reasonable at around 15 times, the US market is somewhat expensive despite the de-rating seen last year, and Europe is cheap. If we do get a recession, then stock market valuations could de-rate by another 10%. It’s difficult to build a case for any material upside for valuations given the expected rate environment and while earnings expectations are likely to be cut further. Corporate earnings have been remarkably resilient given the macro environment, with current consensus expecting flat to low single-digit earnings growth this year. But if there is a recession, then earnings could fall at least 10% to 15% from here. Relatively high corporate margins in the US also leave little margin of safety. On the positive side for equities, an expectedly weaker US dollar would be a benefit. Similarly, investor positioning and sentiment are broadly supportive, a peak in US inflation usually bodes well for subsequent returns, a reopening of China’s economy would be a tailwind, and history shows that stock markets usually bounce back strongly after a year of losses to the extent seen in 2022. At the time of writing (mid-January) global equities were already up over 5% so far in 2023. Provided there’s no deep and long recession this year, then I think equities could return a high single to low double-digit return this year. G7 bonds are currently at fair absolute value and relatively attractive versus equity. Commodities should benefit from many factors: tight supply, heightened geopolitical risks, a cyclical recovery in China, and ongoing climate and environmental change policies. They are also a good inflation hedge. In the circumstances, a balanced portfolio of different asset classes is warranted and is likely to produce moderately positive single-digit returns this year.

  CH: A weak year for developed market equities, emerging market equities finally outperform, aided by a weaker US dollar. Global fixed income outperforms equity as inflation declines. Commodities to rebound on the back of stimulus out of China and low inventory levels.

  ZD: The reopening of the world’s top consumer of commodities will benefit commodities and currencies of commodity exporters. A change in gear in US monetary policy will weaken the US dollar and gold will do well in such an environment. Peak inflation and peak interest rates will be positive for equities, while downside risks to earnings based on deteriorating economic growth and the lagged impact of higher interest rates will offset this. As such, a cautious stance on equities is warranted.

  JW-E: Bonds are a better risk diversifier for now (but don’t get wedded to this idea!). There’s a lot of left-tail risk in equities that have been removed (eg EU gas/China zero-Covid) and it looks as though the US could prove more resilient. But a perfect soft landing as per Captain Sully on the Hudson still looks like a low-probability event to me. Small underweight risk assets for now, but I can see opportunities to go nicely overweight later in the year.

  AP: The rapidly falling inflation numbers will help support G10 government bond prices in the first instance. This, as well as possible upside surprises in growth from Europe and Japan, could see equities in the rest of the world do well and if China has a boom year similar to what other economies had post-Covid-19, then equities might surprise on the upside despite lower earnings expectations. The fall in longer-dated bond yields will provide a good floor under growth assets and I feel that even here we will see equities improving despite the earnings headwinds as growth stocks have a longer duration. The weakening dollar will also support the risk assets in the rest of the world.

  OM: Bonds are a good hedge against risks; local equities should perform better than global equities on a relative basis; the rand should be stronger on the back of a weaker US dollar; commodities (in terms of volumes) should benefit from the China reopening although elevated prices may come under pressure.

  BS: Over 12 months I am optimistic that emerging markets, Europe/UK and commodities will do well. While I believe the US will muddle through economically with a mild recession, US corporate profitability is overextended and valuations are not that attractive yet. Lower energy prices could allow Europe and the UK to surprise on the upside off a very low base and expectations. I expect a weaker US dollar and I am optimistic about bonds in the shorter term.

  BK: I like fixed income. Equities do not frighten me – the US dollar is neither friend nor a threat to emerging markets, including the JSE or the rand. Commodities look well supported. I think a continuation of year-to-date trends (favourable to dollar investors in the JSE) may well continue.

• Turning to South Africa, what does all the above imply for the South African economy and local markets?

  ZD: As a small open economy and commodity exporter, South Africa will be lifted by global trade. The positive impact of a resurgent China will shield South Africa from the looming global slowdown/recession, while deglobalisation will have positive short- and long-term impacts. Developments on the global front and a weaker US dollar should reduce upside inflation risks. However, South Africa’s idiosyncratic challenges, including Eskom, Transnet, and politics will weigh on growth.

  OM: Emerging markets should benefit from a weaker US dollar, while emerging market inflation is better positioned to be under control in the short-term, compared with the sticky inflation in developed markets. China’s reopening should also be supportive of emerging markets and SA. However, global macro conditions remain a threat to SA’s performance and, of course, Eskom is the main major headwind for local markets and confidence.

  RC: Assuming no (meaningful) global recession, the outlook for commodities is decent, which should underpin local economic growth. SA equities are trading on a high single-digit PE valuation, the cheapest since the Global Financial Crisis - even factoring in a pessimistic growth outlook, the SA stock market appears to be overly discounting bad news. Positive single-digit corporate earnings growth and a dividend yield of around 4% also provide a cushion. The SA long bond yield on a low double-digit starting yield provides a significant margin of safety, despite the global rate environment and longer-term SA fiscal uncertainty. So, SA assets should stack up relatively well in terms of their potential returns this year.

  CH: We would normally do well in this environment but the failures at Eskom will put a cap on SA GDP growth. Even so, we expect GDP growth of around 2%, which is above consensus. The local market is cheap, with still decent earnings growth.

  BS: It could be a good year for South Africa if commodities continue to do well. This will largely depend on China’s growth. Load shedding will hold many companies back and those that can and do switch to renewable solutions will do better. Valuations are still attractive.

• Load shedding, Phala Phala, elective conference, there was a lot to keep us busy on the local front in 2022. President Ramaphosa has a number of challenges ahead of him in 2023. Do you think the government will be able to address these challenges ahead of the elections in 2024?

  OM: Load shedding will remain a key constraint to South African economic growth and global competitiveness. The base case should be similar or worse load shedding this year in comparison with 2022. Accelerated government intervention in the energy sector is the only catalyst and the risk of the ANC losing an outright majority in the 2024 general elections is the greatest driver for accelerated reforms.

  The elective conference was positive for the country, although the margin of victory is still not convincing. Mbeki was elected unopposed for a second term while Zuma was elected with a +-80% majority in his second term despite Nkandla and Gupta scandals unfolding.

  Employment and infrastructure goals will probably be central to the government’s efforts in 2023. Infrastructure spending tends to plaster the unemployment issue through Public Works programmes, etc. Fixing Eskom is key to starting to fix employment issues in South Africa.

  The 2024 elections will be highly contested. My view is that the deployment of Patricia De Lille (Good Party) as a minister and the appointment of Nkululeko Hlengwa (IFP) as Chairperson of SCOPA were well-considered moves, in case that the ANC is below 50% but above 45% in 2024 elections. The IFP continues to make major in-roads in KZN, with the scope to address the lion’s share of the shortfall of the ANC (IFP 3.38% in 2019 elections).

  BS: I am not optimistic they will have much success and this is why corporates need to become self-sufficient (as they have been already in many cases).  The more public/private partnerships that happen the better (there are promising opportunities in energy and rail).

  NU: Current evidence and recent performance suggest no. There are some glimmers of hope and a positive resources cycle may buy the country and ANC time.

  ZD: I don’t expect these challenges to be resolved ahead of the 2024 elections. It will take years to resolve Eskom’s woes. As Ramaphosa advances in addressing corruption, the RET faction is doing all in its power to sabotage the prospects of success for his presidency.

  RC: There are many SA-specific growth constraints, primarily Eskom’s load shedding (electricity shortages) but also a structural decline in productivity, high unemployment (jobless growth), the high cost of doing business, corruption, high public debt, a lack of sufficient fiscal consolidation and public sector expenditure cuts, still insufficient economic reforms (renewables, labour and SOEs) and worsening social imbalances. Now that the ANC election is out of the way and the President has cemented his support base, the hope is that (some of) these are actively tackled. There’s an incentive for the government to do so if it wants to stay in power come 2024. Unfortunately, despite some incrementally positive steps it’s failed to meaningfully do so to date, and on balance I don’t see that changing.

• Which are the markets/geographies to watch in 2023? Developed or emerging markets?

  NU: Both but for different reasons – for me emerging market corporate governance and shareholder rights etc are key issues. For developed markets, many issues apply but US equity market performance in key.

  AP: I am an optimist on European and Japanese markets, as both have been resilient given the energy crisis that is abating and both regions should avoid the recession that was previously priced in. Emerging markets will benefit from China as well as stronger domestic growth given lower food and fuel prices.

  CH: India – it could well be a watershed year for India as growth materially exceeds what we are seeing elsewhere.

  ZD: Emerging markets are likely to outperform developed markets on account of the China rebound and attractive valuations.

  JW-E: I like emerging markets on the US dollar peak, value, China policy shift, reasonable inflation position and still low positioning.

  RC: Assuming no (meaningful) global recession then emerging equity markets should outperform developed ones. Europe has a lot of catch-up potential and is expected to perform best of the developed stock markets. However, if we do get a nastier-than-expected recession, the US and the dollar should lead benefitting from a relatively safer-haven status.

  OM: Commodity exposed emerging markets – the China reopening is the main driver. Under-rated emerging markets, where valuations look cheap. SA – a stronger rand is also a positive.

• What are the sectors to watch? Look at cyclicals vs defensive, growth vs value, offshore vs local, industrials vs resources, bonds vs equities, tech, etc.

  ZD: While there will be some rotation into cyclicals in anticipation of monetary policy easing, the increasing risks of a global growth slowdown/recession will create a lot of volatility to the benefit of defensives. As rate hikes slow, long-duration assets such as technology stocks will benefit.

  OM: Among equities, I would look at resources, non-discretionary retail/staples, food producers and tech (Naspers and Prosus).

  RC: Cyclical stocks have recovered quite strongly over the last few months and may be due a breather in the short term. Within equities, I currently prefer materials (commodities) and industrials from a cyclical perspective and select consumer staples and healthcare stocks for their defensive attributes. Investors still need some selective technology exposure, where valuations already discount a lot of potentially bad news, given their long-term secular growth tailwinds. Although longer-duration sectors like technology should face a less challenging macro environment this year, there is still a lot of uncertainty around their near-term earnings outlook. Value as an investment style outperformed growth by well over 20% last year as the latter bore the brunt of investor concerns over sharply rising inflation and interest rates. Although value still looks relatively cheap versus growth, I would expect more convergence in performance between the two styles this year – growth appears oversold relative to value in the short-term and in a slower economic growth world where growth becomes scarcer, better quality growth should come back into vogue.

  AP: G10 government bonds will be the first to benefit as inflation numbers come down. This will support longer-duration stocks (companies that are expected to earn the bulk of their cash flows in the distant future), but value stocks, which are shorter in duration, might have to wait for interest rate cuts. However, the upside growth surprises will lift all boats and China will be a (good) added flavour to help markets recover from the terrible 2022 that saw wealth destruction at an unprecedented level.

  CH: Resources given the rebound in China. Local is likely to do better than developed markets in my view.

  BS: I think it could be a tale of two halves and what works in the first half may not work in the second. What I think will be more important will be focussing on cash flow, valuation and growth. Well-managed companies that are growing, generating good cash flow and are available at valuations that are attractive compared to longer-term historic levels should generally do well.

  NU: I prefer value over growth as a key theme. What sector leads the next up leg in markets is really important and one of the candidates might be the financial / banking sector.

• What are some of the other trends/themes we should be keeping an eye on in 2023 that could have an impact on investment?

  BS: The politicisation of ESG in the US is worth watching. It seems to be a key issue presidential hopeful Ron Desantis is focusing on. Interestingly, they don’t appear to understand that ESG is not exclusionary and rather just a deeper level of research to augment your assessment of non-financial factors that could impact a company’s future profitability or existence. But then again, politicians generally never seem that focussed on anything beyond the next four years.

  ZD: Deglobalisation will see capital investment on a massive scale. There will be winners and losers. Companies that are geared to this renaissance of capital spending and commodity exporters will do well, while those that were beneficiaries of globalisation will be hurt by this.


  The fertility conundrum will have immediate consequences on the working population and implications for secular labour shortages and global growth. US fertility rates have plummeted to below replacement level, while some European countries, and China recently, have been battling this scourge with little success despite government policies to reduce the cost of having a child.

  AP: Green energy is a theme that will get attention as Europe will be incentivised to find alternatives to cheap Russian gas. This will be a theme that will play out over several years.

  JW-E: ESG/green energy has been smashed down but the underlying themes persist. A warming world leads to non-linear climate events. Supply chain reconfiguration. How do governments reduce debt without causing too much pain? The ticking time bomb of unfunded public sector liabilities, for example, healthcare/pensions.

  RC: The continued greening of industry, energy security, transition and decarbonisation, disruptions in the life-science space, a chip (semiconductor) war, cyber security, the digital revolution of business, ongoing AI developments in the chatbot space, and cloud computing.

  CH: The energy transition and implications for commodities (and a vast array of other sectors. For example, we could start to see stranded assets in the UK property market as investors struggle to refit buildings to meet environmental standards).

  NU: AI and tech’s influence on inflation are important. Onshoring as a theme is also important. Frontier markets and emerging Asia may surprise on the upside.

• What would be your “Grey Swan” events for 2023 – defined as events with a very low probability but a big impact (black swans by definition cannot be assigned a probability at all)?

  OM: Asian tech, notably Chinese tech regulation and the China reopening and its implications. Food inflation in the light of a supply chain recovery. The green energy transition and commodities. The extent of the developed market recession (will it be shallow or will the market be wrong just like “transitory inflation”?)

  JW-E: Some sort of oil supply disruption (leading to a big spike in oil price). US debt default. Major global internet/satellite outage – possibly from a massive solar flare, but it could be cyberterrorism. Someone eats another bat sandwich. Is there a positive grey swan? Some sort of energy breakthrough?  I suspect nuclear fusion is too far off.

  RC: A financial blow-up in European or Chinese banks, social unrest in China and or an invasion of Taiwan, an intensification of the war in Ukraine leading to a wider global conflict with food and energy inflation spiralling, central banks hiking rates much higher than expected leading to a housing crisis in Western economies.

  CH: Putin removed from power; US debt ceiling not raised; further material progress on fusion energy.

  BS: More frequent extreme weather events as a result of climate change could put upward pressure on inflation.

  NU: So many Swans swimming around at present that it’s hard to think of any that are not now topical or considered. Even a major energy breakthrough would not qualify as it’s a known. Something from space might be a black swan – an unknown intelligence – a discovery etc.