The first weekly review of the year takes a brief look at the events of the past year and reflects on the outlook for 2023 from an investor’s perspective. Economic growth is emerging as the main theme of the year.
2022 was an exceptionally weak investment year. There have rarely been years when both equities and fixed income investments have been so strongly in negative territory. Excluding the financial crisis, we have to go back as far as the 1970s to find a market year as difficult as 2022.
Not only did both fixed income investments and equities perform poorly, but their mutual correlation also increased clearly during the past year. That means that when equities have fallen, diversification across asset classes has not provided the same kind of short-term protection as before.
The key market themes for 2022 were soaring inflation and the end of the zero interest rate policy era. In 2023, both inflation and central bank interest rate policies are expected to be considerably more predictable, and economic growth, or rather, the lack thereof, is expected to take centre stage as the main market theme.
The economic slowdown has primarily been driven by high energy prices in Europe, by a reduction in domestic demand in the USA and by the zero Covid policy in China.
The growth indicators that provided positive surprises last autumn, such as PMIs and consumer confidence surveys, will be put to the test early in the year. The US PMIs published last Friday were significantly weaker compared to last month’s figures, and the Michigan University’s consumer confidence index that will be published next week may contribute to weakening the economic outlook, if the figures prove to be low.
A recession continues to be the most likely scenario in the Western countries, although the starting point looks better now compared to previous recessions. The US labour market is on a solid footing, and the indebtedness of the Western countries is at a reasonable level.
Monetary policy is likely to remain tight in 2023
A third of all dollars in circulation were printed in 2020. The amount of new money decreased dramatically in 2022, when the US and euro zone central banks decided to tighten their monetary policy. This marked a major change in direction.
It appears that key interest rates will be raised several times in both the USA and Europe before the peak of the interest rate cycle in early summer. The general market expectation is for the USA to start cutting interest rates in the autumn of 2023. These expectations may, however, prove to be overly optimistic.
The predictions of interest rate cuts are based on the idea that when the economy is struggling, the central banks will be pushed to ease their monetary policy. The big question for the current year is whether this really still holds true, with inflation remaining clearly above the central banks’ target level.
Volatility shifting from fixed income to equities
Weakening growth prospects are still causing uncertainty in the equity markets where pricing continues to be tight, especially in relation to the fixed income markets. The weakening of growth prospects has increased volatility in equities, and the historically weak equity year clearly lowered the risk premiums on global equities.
At the same time, the return expectations on fixed income investments are looking very attractive. The higher return expectations also provide investors with a buffer against a widening of risk spreads as a response to a weakening outlook. Key interest rates will keep the fall in interest rates in check in the early part of the year.
Regardless of when the interest rate cycle turns downward, the interest rate policy and inflation are now much more predictable and stable than six months ago. That means that the volatility of fixed income investments is likely to stabilise over the course of the current year.
The weakening of the economic outlook affects alternative investments with a delay, and the pressure seen in liquid asset classes is likely to reach alternative asset classes during this year. From the perspective of new investments, however, falling valuation levels are welcome.
Nothing presented here is or should be taken as an investment recommendation or solicitation to subscribe for, buy or sell securities. When making investment decisions, the investor must carefully familiarise themselves with the information given on the financial instruments and understand the related risks. The investor must base their decision on their own assessment, goals and financial situation. Risk is always inherent in investment activities. The value of the investment instruments may increase or decrease. The past performance of investment instruments is no guarantee of future performance.