Market Update:: The Pariah’s View for 2023

General Advice Warning :: Please consider any advice or views provided in the below, general in nature and that no consideration has been given to your personal needs, objectives or circumstances. Unless it is indicated otherwise. You should consider if this advice is appropriate for you.

The Pariah’s View for 2023

To my valued reader’s,

It’s hard to believe that 2022 is already coming to a close but I would like to take a moment to express my deepest gratitude for your support.

It’s this time of the year where we take the opportunity to reflect on the year that was. The team at Morgans Financial Limited is very proud of what we have achieved during 2022 including:

• celebrating the 40-year anniversary of Morgans
• being named Best Australasian Retail Broker at AIRA’s 2022 Best Practice Investor Relations awards for the sixth time
• winning the Small Cap Execution award in the Peter Lee Survey
• producing 3,500 research products and notes containing valuable insights
• our Morgans Foundation donated over $2.3 million to Australian charities in 2022
• our annual charity day Big Dry Friday raising $1.3 million for rural and regional Australia

These achievements mean that Morgans continue to provide top-line advice and investment opportunities that benefit clients across our national branch network.

Financial markets have faced a tumultuous 2022 as a new regime of higher macro volatility took shape. 2022 will long be remembered as the year of rising inflation and interest rates. Indeed, in 2022 we witnessed the fastest pace of cash rate increases since 1994. As we look to 2023, the most important question is actually quite simple: can inflation be tamed as economic activity slows? I am optimistic, but there are substantial risks. Fortunately, there are convincing signs that inflation pressures are abating and 2023 is shaping up to be a much better year for investors. As shown in this chart from State Street (US) there wasn’t an asset class with a positive 12 month performance.

I remind readers to remain vigilant against a series of macro-economic noise that are likely to make for a bumpy ride and as always, some asset classes will outperform others. That is why I have included some of my key themes for 2023. As always, speak to your adviser (or myself) about asset classes and stocks that suit your investment goals.

2022 has been a challenging and disruptive year and I appreciate your ongoing support as a valued client or reader. I wish you and your family a safe and happy festive season and look forward to sharing with you a prosperous 2023.

When The Wind Changed

As an avid surfer part of the skill to getting good waves was your ability to predict swell direction, wind and calculate them with tides. You are always racing to get a few before the winds changed, and in 2022 the financial markets had the strongest wind change generated by Central Banks we have seen since the 1970’s (albeit excluding events like a debt and/or energy crisis, tech disaster or a pandemic), which would eventually help create storm like conditions. Some of these winds were:

• The massive increase in interest rates had its usual depressing effect on bond prices.
• Higher interest rates led to higher demand on returns. Thus, stocks that had seemed fairly valued when interest rates were minimal fell to accommodate lower p/e ratios that were adequate with higher rates.
• Falling stock and bond prices caused FOMO to dry up and fear of loss to replace it.
• The markets’ decline gathered speed, and the things that had done the best in 2020 and 2021 (tech, software, SPACs, and cryptocurrency) now did the worst, further dampening psychology.
• Exogenous events have the ability to undercut the market’s mood, especially in tougher times, and in 2022 the biggest such event was Russia’s invasion of Ukraine.
• The Ukraine conflict reduced supplies of grain and oil & gas, adding to inflationary pressures.
• Since the tighter monetary policies were designed to slow the economy, investors focused on the difficulty the Fed would likely have achieving a soft landing, and thus the strong likelihood of a recession.
• The anticipated effect of that recession on earnings dampened investors’ spirits.?Thus, the fall of the S&P 500 over the first nine months of 2022 rivalled the greatest full-year declines of the last century.?(It has now recovered a fair bit.)
• The expectation of a recession also increased the fear of rising debt defaults.
• New security issuance became difficult.

The progression of events described above caused pessimism to take over from optimism. The market was characterized by easy money and upbeat borrowers and asset owners disappeared; now lenders and buyers hold the better cards. Credit investors are able to demand higher returns and better creditor protections. The table below exhibits the wind change that has taken place.

We are now surfing a totally new set of waves from a new swell, with different winds and the ebbs and flows of the tide keep distorting the prospective views for the near term. A term that was heavily used in the recent pandemic times was ‘unprecedented’ and that is where financial markets are today. A lot of the ‘smart people’ in the room always look at historical references (e.g. US Fed Chairman – Paul Volker in the 1980’s) as to guide and model the way out of the current swell.

I don’t believe that this can be used today and nor will it prove successful. Just as we are in unprecedented times for the financial markets, we are also in the most technologically connected world along with capacities and capabilities from global leaders, be it Central Banks, Governments & Corporately, to absorb and be flexible as to keep the economic momentum positive.

For this reason you need to remain optimistic towards the global economy and financial markets for 2023!

2023: The year for the Pariah’s View!

Towards the end of what has been a tough year for markets, many investors are searching for signs of a market bottom and wondering, “Are we there yet?” The short answer is “Not quite.” (in global markets, the ASX looks to have found it but may re-test the lows) While stocks recently staged another rally, Morgan Stanley ’s Global Investment Committee believes this latest bounce is temporary, driven by technical factors, and that the bear-market bottom is still to come.

First remember that the nature of this bear market is different from others in recent history. The Federal Reserve’s deliberate tightening of monetary policy, rather than a financial or economic crisis, is driving this downturn. Why does that matter? During crisis-fuelled bear markets—such as the 2001 dotcom bust, the 2008 housing-related financial crisis and the 2020 pandemic-driven crash—a rapid easing of monetary policy was the antidote. This time, however, policy tightening will likely be the cause of economic slowing, as central bankers are forced to combat inflation; historically, this kind of bear market tends to be more prolonged.

Mark Haefele , CIO at 瑞银集团 Wealth Management raises the point that “aside from coinciding with the anticipation of Fed rate cuts, historically, markets have also tended to trough between three and nine months before economic activity and corporate earnings reach bottom, as investors anticipate a turning point for growth. So, the timing of a turnaround in economic and earnings growth will be a key inflection point for 2023”.

Next year is likely to see weaker growth, less inflation and the end of rate hikes, with the U.S. narrowly missing a recession, Europe contracting and Asia offering green shoots for growth. Expect 2023 to have upside for bonds, defensive stocks and emerging markets. Morgans Stanley see other key takeaways for the global economy going into 2023:

• U.S. economy will tread water with 0.5% growth.
• Economies in Europe and the U.K. are likely to contract.
• Emerging market economies should recover modestly.
• US 10-year Treasury yields will end 2023 at 3.5% vs. a 14-year high of 4.22% in October 2022.
• S&P 500 will tread water, ending 2023 around 3,900, but with material swings along the way.
• U.S. dollar will peak in 2022 and declines through 2023.
• Emerging-market and Japanese equities could deliver double-digit returns.
• Oil will outperform gold and copper, with Brent crude, the global oil benchmark, ending 2023 at $110.

Overall, investors will need to be more tactical and pay close attention to the economy, legislative and regulatory policy, corporate earnings and valuations, says Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. “Because we are closer to the end of the cycle at this point,” Wilson says, “trends for these key variables can zig and zag before the final path is clear.?While flexibility is always important to successful investing, it's critical now.”

Seth B. Carpenter, Morgan Stanley’s Chief Global Economist commented “As consumer goods’ supply chains recover and labor markets see less friction, we could see a sharper and broader fall in inflation, which would imply a somewhat easier path for policy and higher growth globally.”

J.P. 摩根 can see the winter will aggravate China’s COVID policy and Europe’s natural gas problems may persist. The global economy is projected to expand at a sluggish pace of around 1.6% in 2023 as financial conditions tighten. This is again similar to 美国道富银行 (US) views shown above. Within these charts we can see Global Economic Growth has been revised down to around 2.6% as too the S&P 500 earnings for next year look to be at 6%.

J.P. Morgan says the global economy is not at imminent risk of sliding into recession, as the sharp decline in inflation helps promote growth, but a U.S. recession is likely before the end of 2024. In the first half of 2023 however, the S&P 500 is expected to re-test the lows of 2022, but a pivot on interest rate language from the Fed could drive an asset recovery later in the year, pushing the S&P 500 to 4,200 by year-end.

They (like myself) see ‘From a valuation standpoint, we believe there has not been a more attractive entry point for a traditional portfolio of stocks and bonds in over a decade’.

Mark Haefele, CIO at UBS Wealth Management comment really resonates, and I think is a good basis as to set the view for 2023. “As we look ahead, in our base case, growth in Europe should start to improve in mid-2023 as the continent’s energy crisis begins to ease after the winter. In China, economic growth should also improve, contingent upon a midyear reopening. In the US, a trough is likely to come later given the current momentum in the economy and the lagged impact of tighter monetary policy. But during the second half, consumption and investment should find some support provided inflation is lower and financial conditions are looser.

Overall, global growth should trough around the middle of the year, even if it remains relatively sluggish until 2024. This suggests that a more constructive environment for risky assets should start to emerge during the year, as markets anticipate potential turning points in economic and earnings growth rates.

Exactly when markets start to price a more favourable growth outlook will depend on how far into the future investors are willing to look, and whether the world can avoid another geopolitical, financial, or epidemiological accident in the meantime.”

2022 tested the resolve of many investors, but better days are likely ahead. I believe markets could stabilize even as the economy worsens in 2023. The global reset in valuations is presenting investors with a broader range of viable options to help achieve their goals. Most importantly, I encourage you to focus on your process: Define and revisit financial goals; then design investment portfolios that may provide the highest probabilities of reaching them.

Recent Howard Marks, Co-Chairman of Oaktree Capital Management, L.P. Capital express a timely reminder about investing: “I think most people would be more successful if they focused less on the short run or macro trends and instead worked hard to gain superior insight concerning the outlook for fundamentals over multi-year periods in the future.” They should:

• study companies and securities, assessing things such as their earnings potential;
• buy the ones that can be purchased at attractive prices relative to their potential;
• hold onto them as long as the company’s earnings outlook and the attractiveness of the price remain intact; and
• make changes only when those things can’t be reconfirmed, or when something better comes along.

2023 predictions:

US:

• S&P 500 earnings will continue to be resilient whilst the economic conditions continue to be laggard to the spat of Fed interest rate hikes. Because of this the market p/e will steadily make the index climb towards 4,600. The Fed will pause and hold at 5% to 5.25% and wait to see what happens in 2024. Unemployment will rise to around 4% but this wont drive the economy into a recession, leaving the consumer to continue to be buoyant.

Europe:

• Everyone is hopeful that the Ukraine/Russia war deescalates and is resolved. No one will be able to predict the outcome here. Europe though is focused on the job at hand and has secured enough energy for the winter. The current drought being felt through eastern Europe will impact agriculture however it will have a positive effect from imports driving productivity. Markets are pricing a deep recession here and this myth will be proven wrong in 2023 due to the robust households and the fact they get to the other side of winter in good shape.

Emerging Markets (EM):

• Whilst China will still be juggling its COVID policy, the lower economic activity and very poor housing market will be a drag on the economy. Growth will be at its lowest in decades (still positive). Picking up pieces will be India and other Asian country’s. EM is looking really attractive from a growth perspective, especially with an Asian tilt, and is neutrally placed to service developed markets. More on this in 2023.

Australia:

• 2023 is going to be docile year for the Australian economy. The RBA will finish with interest rate increases in March finishing at 3.6%. Unemployment will rise along with consumer spending easing due to so many households dealing with the new cost of mortgage rates. Whilst this wont push Australia into recession, it will cause a pause through the largely consumer driven economy for most of the year. CEO’s will use cautious commentary in their half yearly reporting in Feb leading to the market re-testing valuation low’s (ASX 200 1yr forward p/e of 15x). As the global growth reset thematic takes over mid year I would expect the ASX 200 to finish the year up around 7,700 along with a healthy gross dividend yield of 8%.

Note:

The Pariah's View came about because throughout 2022?I?was finding my view's of the markets and global economy greatly different to those from market commentators & strategists. The meaning of a?Pariah is to be an outcast: one that is despised or rejected. Also it is originated from southern India, which might also play into favour for 2023!

Should you have any further queries, please do not hesitate to contact me.

Regards

Scott Fraser

Private Client Adviser

Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410

General Advice Warning :: Please consider any advice or views provided in the above, general in nature and that no consideration has been given to your personal needs, objectives or circumstances. Unless it is indicated otherwise. You should consider if this advice is appropriate for you.

Some References:

• https://www.ubs.com/global/en/media/display-page-ndp/en-20221117-ubs-year-ahead-2023.html
• https://www.ssga.com/library-content/pdfs/etf/au/spdr-au-monthly-chart-pack-etf.pdf?
• https://assets.jpmprivatebank.com/content/dam/jpm-wm-aem/documents/en/investing/outlook-2023.pdf
• https://www.morganstanley.com/ideas/global-investment-strategy-outlook-2023?subscribed=true&dis=em_20221130_wm_5ideasarticle&et_mid=397996&et_mkid=&sfmc_id=181873199
• https://www.oaktreecapital.com/insights/memo/sea-change