The watchword for investors in 2023 is patience. Be patient for a new economic cycle to begin, as falling interest rates, a weakening dollar and a recovery in business and household confidence come together. Then, it will be safe to take long positions in stocks, credit and other risk assets.
This is what many of the 2023 outlooks from investment banks’ capital market strategists are telling us. This commentary outlines the case for why they may well be right and a fresh bull market may start next summer.
But financial history shows that long-term investors are better served by treating such forecasts with immense caution and not trying to time, precisely, when to take on or reduce exposure to certain asset classes.
But forecasts suggest an ability to time the market!
The writers of these notes imply that we can and should stand aside from the bear market rallies that we have seen repeatedly this year, confident in one’s ability to know (or be told) when the stars are correctly aligned. Then, we can take the plunge, buy risk assets, confident in the knowledge that the next real bull market is about to start and that we got in at the cheapest point.
But this implies an ability to correctly time the market, which we know from experience to be very hard to do. Even if the strategists are correct in their forecasts, we all too often follow the herd when it comes to investing.
For instance, the best time to buy stocks is often when the global economy is weak, but the worst of the bad news is behind us. The interest rate cycle is turning downward, as inflation and growth are falling. But it may be that recession has killed all hope and investors cannot bring themselves to take the plunge.
Long-term investors often do better ignoring market commentators and buying the market whatever the prices. Distinguishing a bear market rally from the start of a bull market, while it is happening, is near impossible. Too often, the investor, who sits on cash, waiting for the stars to align, misses the early stage of the recovery, which can often see the highest returns.
Regular savers will find that the effect of dollar-cost averaging means that market downturns actually help drive returns over the long term, since more shares can be bought, say, for every $100 of monthly savings.
Lump sum investors, meanwhile, can take comfort that global stocks are significantly cheaper than they were a year ago. The MSCI ACWI index of developed and emerging stock markets is down 14% in local currency terms (but more in dollar terms, and less in sterling, reflecting dollar strength and sterling weakness this year). Anything over 10% is considered a correction.
Why might the markets turn in mid-2023?
Having advised against trusting in their market timing, the current consensus from investment bank capital market strategists on the macroeconomic scenario for next year appears reasonable.
It is for bear market conditions to persist into the first half of 2023. Recession in Europe and slow growth in the U.S., will reduce corporate earnings. Meanwhile, global interest rates will continue to rise, the combination may well lead to falls on global stock markets. Particularly given that risk-free alternatives, such as government bonds and -to an extent- bank account cash, will be offering increasingly attractive returns.
The good news is that, with inflation falling in the U.S. and likely to roll-over in Europe over the coming months, it is likely that interest rate hikes will come to an end over the next six months. Much will depend on slack developing in labour markets, i.e., a rise in unemployment. This is because rising wages -particularly in the U.S. and the U.K.- risk creating an embedded inflation problem that central banks are keen to avoid. It currently appears that both the Fed and the Bank of England will raise interest rates until labour markets weaken.
Eventually global interest rates will peak, with current bets being in the second quarter. Economic data by then may be very weak and investor sentiment poor. But this may well be the time to invest in the next economic cycle.
What might go wrong?
The likely re-opening of China, from its Covid lockdowns, will boost global supply, so easing supply chain problems in manufactured goods. This will help reduce global goods price inflation. But it may be that a China reopening is inflationary in its total effect, as pent-up demand within the country leads to a rise in the prices of global tradable goods and in the prices of the raw materials used to make them. Global growth may be stronger next year as a result, which would be good news. But if it results in higher inflation, it will mean global interest rates continue to rise.
Geopolitics is sure to move markets at various times next year. Could it be a Chinese assault on Taiwan, a breakdown in the U.S. political system, or Putin invading another neighbour? We cannot rule out a financial crisis, as rising borrowing costs expose over-leveraged players and markets, or another Covid pandemic as strains mutate.
U.K. stocks, gilts and sterling
It is hard to like any U.K. asset class except the world-class multinationals to be found in the FTSE 100 index. These companies, most of which are in ‘old economy’ sectors such as energy, pharma, financials and consumer basics, are solid defensive plays in the current economic environment and attractively valued compared to their global peers (especially in the U.S.).
But U.K. small and mid-cap stocks will suffer from their direct exposure to the U.K. economy next year. In November, the Office of Budget Responsibility (OBR), forecast a 7% fall in real disposable household incomes over the next two years due to inflation, increased taxes and mortgage payments. The IMF has forecast that the country will have biggest downturn in GDP in 2023 of all the G7 countries, except Russia.
Gilts are vulnerable to a repeat of September’s market sell-off. Political risk has not disappeared, given the struggle Prime Minister Rishi Sunak has in getting his 80 Conservative MP majority in Parliament to agree amongst themselves.
The risk of oversupply has grown, given the projections for a growing budget deficit over the next two years (ahead of the 2024 election), while the economy contracts. The so-called ‘moron premium’ in the gilt market that came when Liz Truss became Prime Minister, is still to be seen in the excessive spread of gilts over bonds, compared to the mid-summer level.
Bets on falling inflation and global interest rates pivoting next summer, are perhaps better taken with U.S. Treasuries and investment grade credit.
There are many reasons to dislike sterling, such as a structural low-growth problem in Britain and an increasing current account deficit. However, the interest rate differential between the dollar and sterling is likely to shrink, once the Fed begins reducing interest rates in (perhaps) late 2023. This will undermine a key support for the dollar against sterling over the last 12 months. It is unclear whether it will outweigh the two negative themes mentioned above.
If you must try to time the markets, it appears mid-summer may be a good entry point for buying risk assets. But this is to place a lot of trust in economic forecasting and in one’s own ability to go against the herd and to invest when market sentiment is weak.
Perhaps it is better to be investing now and to be already in the market when the recovery rally when it happens. Sure, there may be further falls to come – or there may not. In the meantime, one is collecting dividends from stocks, that at 1.6% on the S&P 500, and 4.6% on the FTSE 100, comfortably outperform bank account cash rates.
- No Investment Advice: This financial commentary is for informational purposes only and is not intended to be, and should not be, construed as an offer to sell or a solicitation of an offer to buy any security or financial instrument or invest in any equity or investment strategy. It should not be used to form the basis of any investment decision.
- Investment Risks: There are risks associated with investing in securities and past performance is not indicative of future results. Always seek professional advice before investing.
- Not Legal/Tax Advice: This financial commentary is not intended to be, and should not be construed as, legal, regulatory, tax, or accounting advice. Always seek professional advice and consult with your legal counsel, tax and accounting advisors when contemplating any course of action.