This article first appeared in Capital, The Edge Malaysia Weekly on January 16, 2023 - January 22, 2023

EQUITY markets were rattled by the interest rate hikes to tame elevated inflation levels in 2022, which pressured returns in most of the major financial markets. Entering the new year with a dim market outlook, investor interest continues to be lacklustre in the absence of fresh catalysts.

A US Federal Reserve pivot could serve as one if the persistent monetary tightening hurts the US economy. Many are anticipating a recession this year.

“A Fed pivot will be good news for risky assets. Stable global financial conditions, and not tightening, can help such assets. And this is the reason why maybe now is not the time to enter the equity market at full speed. It will become clearer or more compelling this year,” Alessia Berardi, head of emerging macro and strategy research at Amundi London tells The Edge in a recent interview.

Amundi is relatively more positive than the street view, however, as it is not expecting a US recession. “It’s fair to say that there will be at least two to three quarters of flattish growth in the US,” notes Berardi, who sees growth of 0.9% and 0.6% for 2023 and 2024 respectively.

Having said that, the likelihood of a US recession cannot be ruled out, she says. “For us, the probability of a US recession is around 40%. If that happens, the Fed can turn to a more accommodative stance, given that it has been accumulating some buffers,” she adds.

“As of now, the preference remains slightly towards the US equity market, even though we’ve trimmed our ‘overweight’ on US equities. Probably when we move away from the correction phase with a better digestion of earnings, then we will see a favourable trend in other regions, such as Europe and emerging markets. China equities will become more interesting than that of the US in the second half of the year.

“US earnings have not shown any kind of deceleration so far. We have to look for the guidance coming out from companies during the latest corporate results season. Our expectations in terms of US earnings are more negative than what the market is discounting, even though our base case is that the US will not face a recession.”

Last year was Wall Street’s worst since 2008, with the S&P 500 down almost 20%. The tech-heavy Nasdaq even saw one-third of its market value wiped off while the Dow Jones Industrial Average slipped 8.8%.

After the excessive monetary tightening last year that brought the Fed funds rate to 4.25%-4.5%, Berardi expects the Fed to reach a terminal rate of 5.25% this year.

“We do not expect any easing by the Fed during the year. And this is consistent with the kind of inflation outlook that we have. It is also consistent with the fact that we do not expect a recessionary outlook. So, the Fed can afford to stay with higher rates for a longer time,” she explains.

US inflation is projected to expand at a slower pace of 4.3% in 2023 — which is still higher than the Fed’s 2% target. The latest data announced last Thursday shows that US inflation was in line with market expectation, slowing further to 6.5% for December 2022 against 7.1% for November 2022.

Globally, Amundi’s economic growth forecast of around 2% for 2023 is more cautious than the International Monetary Fund’s 2.7% expansion. The eurozone is forecast to contract 0.5% this year, while China’s economy is expected to accelerate from 2Q2023, lifting the full-year growth to 4.4% against 2.9% in 2022. This is partly supported by the reopening of its borders, which saw inbound and outbound travel start last Sunday.

“China’s reopening is for sure a very welcome surprise. But after three years of lockdowns, Chinese households are in a cautious mode,” Berardi warns.

As a result, despite the anticipated acceleration in China’s economy, it will not be as strong as it was before the pandemic, thus leading to a relatively weak global demand environment.

“So, more global growth has to come from domestic demand, be it public expenditure or consumption expenditure, rather than external demand,” she adds.

Berardi points out that while equities are not the favoured asset class in emerging markets in the first half of the year, China’s reopening will act as an important driver.

“We do expect some market improvements moving into the second half of 2023 across different asset classes, where there will be more clarity about growth dynamics. Some economies will improve from the current weakness and that will reflect in better earnings dynamics. In emerging markets, earnings are very much related to exports,” she adds.

Within the equity asset class, Berardi favours defensive and value stocks such as those in the consumer staples and financial sectors, in view of the high interest rate environment.

“We’re close to the peak of interest rates, but aren’t there yet. The increase in interest rates will reflect lower growth and probably lower earnings. Clearly, asset allocation has to stay on the cautious side,” she says.

On the Malaysian market, Berardi says the country’s economic cycle is robust and external demand will be further supported by China’s reopening.

“Equity-wise, Malaysia looks interesting, but it is not the most undervalued country from a global perspective. Probably the Latin American region offers more opportunities in terms of valuation. Nonetheless, it’s true that the economic cycle is good in Asia, including Malaysia.”

When asked whether Malaysia’s political developments are a concern for foreign investors, she says, “It’s not so much the political situation, but how it is reflected in policymaking. Probably the most important topic right now is the fiscal policy on how the government can address fiscal imbalances.

“As a foreign investor, I’m more interested to know how the political landscape affects policymaking, and not so much on the political side.”

On the currency front, Berardi sees an undervaluation of more than 10% for the ringgit — one of the highest in the region. The South Korean won and renminbi are estimated to have been undervalued by more than 15%.

The ringgit touched an all-time low of 4.7387 in October last year on the back of a strong greenback, which hit a two-decade high in September 2022, after the jumbo interest rate hikes in the US. However, Amundi observes that since the beginning of November last year, the correction in the US dollar has been huge, signalling a potential change of tightening framework and offering interesting opportunities and valuations across emerging-market currencies.

Berardi expects the US dollar to remain stronger for a while before depreciating mildly from the current level. “For the time being, if you want to stay away from the dollar, maybe you can play with some safer currencies like the Swiss franc or yen. And later, you can turn to emerging-market currencies if you want to embrace more risk,” she says.

In the commodity markets, supply disruption was the main factor driving the commodity boom in the first half of 2022. However, demand was less of an issue in the second half, leading to the easing of commodity prices.

“Structurally, I believe that the supply factor remains important. Without any doubt, the transition trend is increasing across the world, with some commodities being strategic. While we will witness the upward and downward trends depending on market demand, the supply factor remains important in offering support to prices,” Berardi opines.

“This is why even though inflation is declining, prices will not return to the levels we saw before the pandemic. Even a US recession may imply some weakness in the short term, but it won’t change the global structural trend.”

She expects oil prices to stay around US$90-US$95 a barrel, being the fair value in 2023. As at 6pm last Thursday, Brent crude was trading at US$83.55 per barrel.

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