Friday 29 Mar 2024
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As if to tease investors who were adversely affected for most of 2022, global equities rallied in the last quarter of the year, driven by a possible easing of the pace of US Federal Reserve (Fed) interest rate hikes and China’s potential reopening.

Even so, 2022 was mostly rocky, marred by soaring global inflation, China’s property crisis and stringent Covid-19 curbs, the end of easy monetary policy in developed markets (DMs) (especially in the US) and a damaging war between Russia and Ukraine that placed tremendous stress on global energy supplies.

Investors are currently debating whether a global soft landing should now be the base-case scenario in 2023. We remain cautiously optimistic, however, as there are opportunities for savvy and patient investors to take advantage of during these volatile times.

The inflation question

The key question for 2023 is simple — how will inflation fare this year? In 2022, most central banks in the world (except notably China) adopted an aggressive tightening monetary policy, with the Fed announcing the seventh consecutive increase in the federal funds rate in an attempt to curb four-decade-high inflation levels, albeit at a cost to the economy.

For 2023, markets are anxiously waiting to see whether central banks will continue to hike interest rates even as economic activity slows down. This is what makes the inflation question so intriguing in 2023. So far, the answer seems to be a firm “yes”, at least in the first quarter of 2023. Although inflation will no doubt remain a key concern, we believe it has already peaked.

Globally, food prices are cooling, while natural gas prices in Europe have decreased amid supplies from the US and global supply chains are in the midst of a recovery. All this indicates that inflation is hitting an apex and, more importantly, a number of key global economies are headed towards — or may already be in — a recession.

We are hopeful that this economic slowdown will not be too damaging, unlike the one in 2008, given that the economy remains resilient on the back of relatively better household savings and corporate balance sheets, and the fact that this recession is manufactured by central bankers to curb inflation from an economy that is running “too hot”.

Slowing activity in DMs should motivate central banks around the world to ease the pace of rate hikes — as indicated by Fed chair Jerome Powell — with the European Central Bank (ECB) hopefully closely following suit. For the global economy to fully alleviate inflationary pressures, however, tightness in the US labour market will need to ease. There is currently inflated demand for labour, caused primarily by a declining labour force. This can be attributed somewhat to Covid-19 restrictions, but it is also caused by US domestic labour and immigration policies and an increasingly changing mentality of the US workforce brought about by the Covid-19 pandemic.

Still, we are optimistic that wage growth should ease in 2023, as net job gains decline and labour force participation increases modestly.

Potential rebound for emerging economies

Barring unforeseen circumstances, emerging markets (EMs) should outperform DMs in 2023, as most of the latter, including the US, are likely to be headed towards a recession, weighed down by high inflation and high interest rates. The volatility of 2022 resulted in a challenging year for developed economies, as tight energy supplies, the ongoing war between Russia and Ukraine, slowing growth and tightening fiscal policy have pushed DM economies into recession.

A recession in the US is widely predicted for 2023, even as inflation pressures ease and the Fed begins to end its tightening interest rate cycle. The US midterm elections result of a divided government creates an impasse where long-term problems remain unanswered, with little prospect of comprehensive fiscal support.

In Europe, ECB officials have recently signalled that the growth outlook has notably weakened. Most European Union members now expect a mild recession starting in the fourth quarter of 2022, resulting in increasing vocal support for slowing down the pace of interest rate hikes.

The surge in energy prices has weighed on industrial activity, while high inflation has reduced household income and consumer spending significantly. While we believe the recession scenario in Europe has largely been priced in, the key issues of 2022 have yet to be addressed. Russia’s invasion of Ukraine and its impact on energy supplies in Europe continue to loom large.

As such, we are more optimistic about EM economies — in particular, China. Unlike the US and Europe, real gross domestic product growth in China is expected to grow at 5% in 2023, boosted by a reversal of its strict Covid-19 policies, where the stringent measures were unexpectedly relaxed in late 2022.

In an attempt to revitalise the struggling property sector, the Chinese government introduced a significant financing policy pivot, which resumed bank, bond and equity financing, relaxed escrow account control and allowed more access to credit lines. Also, recent key policy changes appear to indicate that the Chinese government is supporting the real estate sector systematically. In addition, for 2023, the Chinese government is well prepared for various stimulus measures, given that it has experienced neither high inflation nor rising interest rates, unlike the rest of the world.

Finally, we are witnessing the Chinese government extending an olive branch to the US and other countries in an attempt to improve goodwill globally, which encourages future trade and cooperation.

Cautious optimism for the year ahead

Our optimism for 2023 stems primarily from inflation and interest rate hikes finally heading in the right direction. We do not expect inflation to drop to pre-pandemic levels. But against the backdrop of four-decade-high levels in 2022, any relief in 2023 bodes well for the markets.

As the Fed slows down and pauses its aggressive interest rate hikes, and possibly contemplates cutting interest rates in 2023, we expect bond yields to peak and perhaps even fall in 2023, leading to a weaker US dollar. This will provide welcome relief to Asia, as a weaker US dollar will encourage foreign flows back into the region.

We are particularly upbeat on China as it slowly but surely reverses its stringent zero-Covid strategy in 2023, reintegrating itself into the global economy. Monetary and fiscal policies are easing, policy stimulus is back, regulatory concerns are overdone and there is significant upside from China’s reopening. We believe 2023 is the year in which China will prioritise economic development over social and security stability, unlike in previous years.

Notably, investors had been universally pessimistic in 2022, thereby creating an attractive launching pad for better returns in 2023.

A potential wild card in 2023 is the outcome of the ongoing Russia-Ukraine war. Although the current path to a peaceful resolution remains murky at best, any potential resolution will be well received by the market. Inflation pressures could be eased considerably and risk assets, in particular, will warmly welcome any form of peaceful compromises between the two countries.

It is important to note that the battle to rein in inflation is not entirely over, and central banks around the world will now have to navigate a slowing global economy, with a recession looming on the horizon.

Our portfolios will focus on quality and value names in 2023, amid market volatility and high interest rates, as well as selective reopening plays. We continue to like sectors that benefit from key structural trends, such as carbon-neutral industries, technology innovation and energy security. We prefer companies with pricing power as inflation remains relatively higher than pre-pandemic levels and interest rates are higher for longer even as global economic growth eases in 2023.

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