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Our 2023 Global Outlook
Navigating the year ahead
As Marcus Brookes, Chief Investment Officer, explains, 2022 was a year when two inflationary fronts collided. The storm that resulted brought with it the highest rates of inflation in four decades and the most aggressive interest-rate hikes for a generation while leaving investors with little choice but to batten down the hatches.
When the pandemic restrictions began to lift in 2021 it unleashed a great torrent of pent-up demand as consumers were finally able to travel, go to restaurants, buy/sell houses, upgrade their cars, and enjoy many other economy-friendly activities. This was enabled through the government’s decision to support incomes via furlough schemes and accumulated savings from not being able to spend as normal, and low mortgage costs due to low interest rates. This resulted in a ‘demand shock’ – what’s known as ‘demand-pull’ inflation. There was suddenly a great deal of money chasing a limited number of products due to the downscaling of global manufacturing during lockdown, the subsequent decline in global supply chains, and the headline-grabbing logistics bottlenecks that resulted all around the world. For a while, the sun shone. In 2021, UK GDP jumped by 7.4% as a result of the sugar rush of consumer spending.
The perfect storm
Marcus Brookes
For a while, the sun shone. In 2021, UK GDP jumped by 7.4% as a result of the sugar rush of consumer spending.
UK’s lost decade
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Why clean energy is a good investment
As Stuart Clark and Marcus Cave explain, government policy during the dark days of lockdown followed by the great leap in oil and gas prices triggered by the Ukraine war has driven huge levels of new investment into renewable energy creating a wide range of opportunities for investors.
Back to normality?
After a long period of low inflation and low rates, 2022 saw a regime change in markets. High inflation and aggressive interest rate hikes led to a year many investors were happy to close the door on. Helen Bradshaw and CJ Cowan ask whether the new regime is here to stay and, if so, what opportunities this presents.
The value in looking forward
Sacha Chorley and Ian Jensen-Humphreys explain why investors need to look past the noise of today’s investment headlines and the latest market metrics. Investing for the long-term is a forward-looking exercise and, so far, forecasts for future company earnings remain robust.
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With all this in mind, we asked our investment team and the investment experts from some of our Global Partners to look forward at what 2023 could bring for you and your clients...
Following the slight bounce back seen in October, the UK economy unexpectedly grew by 0.1% in November. However, in the three months to November UK GDP fell by 0.3% meaning it was still 0.8% down on its size before the pandemic lockdowns. It is expected that the UK’s shallow, but long-running, recession will be more impactful than the slowdown in the other G7 economies. Indeed, the latest ONS data shows the largest three-year drop on record of UK household real disposable income. The UK’s Office for Budget Responsibility (OBR) has already forecast that the coming drop of 7% in UK living standards from 2021-22 to 2023-24 will erase any gains in UK living standards made since 2014 and that, by 2027, they’ll still be some way behind pre-pandemic levels.
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The complete picture
We asked for the views of the investment experts at some of our Global Partners to discover their outlook and thoughts on the year ahead.
Back to normality
However, in February of this year, the outbreak of war in the Ukraine sent shock waves through food, commodity, and energy markets creating a far more worrying inflationary pulse – so called ‘cost-push’ inflation. There is no way for households to substitute their spending on food and energy, so we quickly found ourselves in the grip of a cost-of-living crisis, which was exacerbated by companies protecting their profit margins and passing on their increased energy costs directly to consumers – greatly increasing the cost of manufactured goods. The result was that UK inflation hit a 40-year high of 11.1% in October before easing slightly to 10.5% in the year to December, meanwhile UK GDP fell by more than half in 2022 as the Bank of England raised UK interest rates eight times to 3.5%, following a 0.75% hike in November and a 0.5% hike in December. They started the year at just 0.25%. In the US, CPI inflation notably eased from 7.7% in October to 6.5% in December in a year when the US Federal Reserve (Fed) led the way with seven interest-rate rises taking the target range for US interest rates from close to zero at the start of the year to 4.25% to 4.5% by the year’s end.
Ian Jensen-Humphreys
Sacha Chorley
Investors in today’s ‘24-7’ digital society could be forgiven for thinking that the outlook for 2023 is rather bleak. Certainly, the daily torrent of headlines and the tone of investment rhetoric has remained downbeat, to say the least. However, for all its furore, 2022 was a year when the MSCI World Index declined by 7.4% while the UK’s FTSE 100, the world’s most notably value-biased major index, outperformed all others to return 4.7%. Although the main US equity indices suffered quite severe losses in 2022, due partly to the Fed’s ramping up of US interest rates, the same rate hikes powered the strength of the US dollar throughout the year, reducing the loss on the MSCI USA Index from 19.5% for US dollar investors to a more modest 9.3% for sterling-based investors.
What’s far more important for investors than the short-term noise is to focus on what drives asset prices on a forward-looking basis and, from this perspective, the outlook for risk investors in 2023 is surprisingly attractive. The Institute for Supply Management (ISM) report is one of the longest-running surveys of US business activity and, consequently, a key economic indicator. Its latest reading for December showed a contraction in US manufacturing, continuing a slowdown that started a year earlier. In recent months survey results like these have corresponded to weak returns from US equities. However, what’s more important to us is what happens in the future. When it comes to stock markets, the two main drivers of shareholder returns are: a) How company earnings are growing; and b) How much investors are being asked to pay for those earnings.
This means that ‘forward returns’ will always look best when investors are able to buy high earnings growth at a low price (or ‘valuation’). Given the amount of data available to investors, it is easy to calculate a ‘valuation metric’ (e.g. by dividing the most recent earnings-per-share figure of a company by its share price). But that does not take into account how earnings figures might change in the years ahead, which is the other crucial part of a shareholder’s return. So, without an understanding of the direction of travel of future earnings, blindly looking at valuation metrics can give a false impression of future returns. Even so, market concerns regarding recession and inflation have already undermined valuations. As the chart (in the pop-up) shows, by far the largest part of the 8.1% loss suffered by the MSCI AC World Index in 2022 was down to the fall in valuations. However, it also clearly shows that a large part of the additional returns enjoyed by sterling investors over the year were the result of a severely weakening pound, especially relative to the hard-charging US dollar.
Ignoring the noise
Valuations impacting returns
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The result of 2022’s numerous shocks and market rotations is that most stock markets are now either outright ‘cheap’ or ‘fair value’ versus their history. This means that valuation is now less likely to act as a headwind to forward returns. That doesn’t diminish the seriousness of the current economic position. The UK is in the grip of a cost-of-living crisis driven both by our reliance on European energy sources and imported food stuffs, and by the fact that most UK households have variable or short-term, fixed-rate mortgages, which means they feel the interest rate rises much more than US households that are now mostly secured against long-term fixed-rate mortgages. Even so, as the chart (inset) shows there are already positive signs emerging. In the US, inflation eased consecutively in each of the last four months of the year while UK inflation finally peaked in October and eased in both November and December. Meanwhile, although talk of a global recession is never far away, labour markets remain resilient, especially in the US.
A comment from Marcus Brookes
Inflation expectations
Source: World Economic Outlook (WEO) October 2022, International Monetary Fund (IMF).
Chief Investment Officer
By the end of 2022, market pricing suggested global earnings growth of between 3% and 12% over the next year. We believe that UK interest rates will peak at close to 4% around the middle of this year and they’re likely to stay at that level for some time. We also think the UK economy will continue to lag further behind other advanced economies, as our households struggle with higher inflation, higher taxes, and higher interest rates. However, these conditions are not that different from those that saw the UK stock market massively outperform its peers in 2022 thanks, chiefly, to the fortunes of its giant oil and energy stocks, which enjoyed record profits, and its number of major banks, which prospered greatly as interest rates climbed and climbed. Consequently, 2022 was the year that pulled the rug from beneath growth stocks, which underperformed value stocks by over 26%. This is because growth stocks tend to be valued largely on their potential future earnings, which become less valuable when prices and interest rates are soaring, yields elsewhere are rising, and a recession is threatening to scupper the growth plans of many companies. Indeed, in 2022 the losses in valuation suffered by the biggest US ‘growth’ stocks, namely Meta (formerly Facebook), Apple, Amazon, Microsoft, and Alphabet (Google) were north of US$3 trillion, a figure very close to the entire value of annual UK GDP. All this has helped to reset the clock for both value and growth stocks in the coming year and we expect quality companies with strong franchises and high barriers to entry in their given sectors to prosper, regardless of the challenging economic backdrop.
As Sacha and Ian make clear, despite all the doom and gloom of recent press commentary, the forward-looking data on company earnings still warrants cautious optimism when it comes to equities in the early part of 2023.
Valuations having the biggest impact on returns
Quilter Investors as at 31 December 2022. Total return, percentage growth of the MSCI AC World Index over period 31 December 2021 to 31 December 2022.
After a relatively benign 30 years, 2022 saw inflation go through the roof. UK interest rates rose above 1% for the first time in over a decade and, by the end of the year, had reached 3.5%. Meanwhile, the historic correlation between bonds and equities, upon which many portfolios rely, completely broke down. Instead of making gains when equities declined, bonds fell sharply as rocketing inflation led to aggressive interest-rate rises, even as economic growth was slowing. Consequently, the situation in which we find ourselves today is unlike anything that many professional investors have encountered in their careers so far. As interest rates approach their peak in the US, UK, and Eurozone for this cycle, and inflation starts to relent, will this herald a return to the ‘normal’ to which we became accustomed in the decade before covid or the ‘old normal’ of the ‘noughties’ and before?
The era of the ‘everything rally’
By flooding markets with ‘cheap’ money, the era of quantitative easing (QE) succeeded in floating all the boats in the harbour – namely buoying companies of every type. This made it a tough period for active managers while helping to fuel the popularity of passively managed (index-tracking) funds. After all, if asset prices are rising due to supportive monetary policy and constant liquidity injections, the most important thing is just to be invested rather than needing to be particularly scrupulous about where you’re investing. For many years, money has been essentially ‘free’. What we witnessed in 2022 was this coming to an end and we’re now returning to the ‘old normal’, where capital is priced appropriately. This should herald a better era for active managers, allowing them to identify companies that will be able to prosper in the coming years.
CJ Cowan
Helen Bradshaw
For many years, money has been essentially ‘free’. What we witnessed in 2022 was this coming to an end and we’re now returning to the ‘old normal’, where capital is priced appropriately.
New opportunities
Whilst the change in market dynamics may feel like unfamiliar territory, it brings with it a number of opportunities. Talented active managers will once again be able to add value as the dispersion in fortunes between the winners and losers should be at its height. Also, after a year of market turmoil, bond yields and spreads have adjusted, and investors are now being paid to hold bonds. Their traditional role in a portfolio of providing a stable return stream has gone some way to being restored and they now have enough of a yield cushion to provide portfolio diversification. As we head into this ‘new’ era, opportunities will arise and an open-minded, flexible, and active approach will be key.
Paying the piper
Alongside the aggressive rise in interest rates, we’re also seeing the unwinding of the bloated central bank balance sheets that have also supported market valuations for the past decade or more. While all this might not sound good, it’s important for investors to remember two things:
It’s human nature to think that the present is especially uncertain and the past was somehow more predictable – this is an obvious fallacy. Uncertainty is good! If you wait until you know what’s going to happen, then there won’t be any returns left on the table. As an investor, you get paid for taking risk, so an uncertain environment is one that breeds opportunity.
As we head into this ‘new’ era, opportunities will arise and an open-minded, flexible, and active approach will be key.
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Of course, when the spread of possible outcomes is this wide, portfolio construction is the key to a positive outcome. Helen and CJ’s approach avoids taking big bets that hinge on a particular, unpredictable outcome and instead focuses on accessing a number of return streams, which should be well suited for the year ahead.
As Helen and CJ highlight, the market regime shifted in 2022, heralding a new era for investors. This brings with it lots of opportunities, with asset classes now back on our radar after years of absence.
According to the Global Carbon Project, for the world to reach net-zero emissions by 2050, its major economies would need to cut emissions every year at a rate “comparable to the decrease observed in 2020 during the coronavirus pandemic.” To describe this as ambitious would be a massive understatement. Even so, great strides continue to be made.
Not surprisingly, the key issue for policymakers everywhere is the importance of balancing energy security (brought into focus by the outbreak of war in Ukraine) and affordability with the need for de-carbonisation. However, no developed country can run before it walks. While the warmer weather in Europe at the start of 2023 has helped to deliver significant falls in the cost of wholesale gas, possibly allowing the region to sidestep the worst of its predicted energy crisis, Europe’s governments still need to maintain a focus on ensuring adequate gas levels for the remainder of this winter while concerns are already mounting over a repeat crisis next winter. Meanwhile in the UK, the government has been forced to keep its estate of de-commissioned coal plants on standby. Thankfully, they haven’t yet been called into service but they’re likely to remain a key contingency in the coming years. We believe, all this additional impetus will act as a further tailwind to the push for renewable energy to account for a far higher percentage of energy production in the next decade.
Renewed appeal
As a consequence, clean energy investment has been growing at an average annual rate of 12% since 2020, according to the latest numbers from the World Economic Forum, while Bloomberg research forecasts an 18% growth in carbon-free energy investment in 2023. Last year alone, the EU saw a 47% year-on-year increase in solar installations, which increased total capacity by 25%. Meanwhile, the US has also seen rising demand for residential solar solutions which will be further boosted by the 30% solar tax credit which forms part of the US Inflation Reduction Act.
However, this would be decided at the country level, which would take time to co-ordinate. To help speed the process of clean energy adoption, the EU adopted new regulations in December to accelerate the permit process for renewable energy projects but, for now, questions remain as to whether such secular regulatory tailwinds can help the adoption of renewables overcome the short-term uncertainties presented by supply-chain bottlenecks and the new windfall taxes on low-carbon power generators. However, we believe the energy security angle alone provides sufficient investment rationale for allocating to renewables – a rationale that many still find more palatable than that of trying to address the climate emergency through which we’re living.
More broadly, the ‘re-shoring’ investment theme, in all its forms, is another beneficiary of these ‘black swan’ events, one which is likely to receive a further boost from any concerted European response to the US Inflation Reduction Act. In the meantime, the very real risk of a complete cessation in Russian gas flows, a colder winter, and stronger Asian energy demand underpin both the need for greater energy security in Europe and the UK and to diversify our existing energy mix towards renewables. We believe the theme of energy transition is a secular one which will continue to drive new investment opportunities for both dedicated responsible investors and for more mainstream retail investors in 2023.
As Stuart and Marcus highlight, the renewables sector will continue to benefit from the upheaval caused by both the pandemic and the Ukraine war.
Marcus Cave
Stuart Clark
The act passed in August 2022 and ensures that billions of dollars will roll toward the US energy transition with an expectation that such policy support will eventually eliminate four billion tonnes of global greenhouse gas emissions. It is expected that Europe will respond to keep European industry competitive and may potentially respond with its own policy, possibly in the form of tax incentives.
Regulatory tailwinds
Paul O’Connor
Head of Multi-Asset
Chief Market Strategist for EMEA
Karen Ward
CIO Equities, Multi Asset and Sustainability
Fabiana Fedeli
Global Head of Macro and Strategic Asset Allocation
Salman Ahmed
Senior Portfolio Strategist, BlackRock Investment Institute
Vivek Paul
The UK has three specific problems undermining its economy and prolonging its inflation woes: aging demographics; geopolitical fragmentation; and the transition to ‘net zero’. Like many western economies, the UK has a rapidly aging population. As the share of the population of ‘pensionable age’ increases, production suffers, tax revenues fall and welfare costs rise. Brexit is a prime example of geopolitical fragmentation; its reduced labour supplies and decreased net migration. Meanwhile, the global push towards net zero emissions as the UK and Europe work towards energy security is a likely source of further supply shocks. The BoE’s recent tightening is the biggest since 1994. By starting in December 2021, it was among the first major central banks to raise interest rates while also acknowledging that bringing supply-driven inflation down to 2% will entail a recession. The cumulative tightening of 3.4% delivered so far has now pushed the country into a recession with the first signs of damage already visible in the real economy. Even so, UK rates have further to go and will remain in highly restrictive territory for some time.
BlackRock
The UK is headed into a technical recession that will extend well into 2024, making it deeper and longer than those in the US or the euro area. UK GDP fell 0.3% in the third quarter of 2022 while the household saving ratio rose and real household disposable income recorded a fourth consecutive quarterly decline.
Fidelity
We expect the UK economy to lag both the US and Europe. There are four pressure points for the UK, namely, the consumer squeeze resulting from the energy shock, sticky inflation, housing market pressures and a tougher fiscal backdrop. While UK inflation has likely peaked and looks set to ease in the coming months helped by the energy price cap, UK core inflation is likely to be somewhat ‘stickier’ than elsewhere, particularly Europe. Continued labour market constraints, partly stemming from Brexit, are a key driver of this. Consequently, the Bank of England faces an unenviable task. It has sent hawkish messages since the Autumn Statement, despite the additional growth drag coming from fiscal austerity. Current market pricing points to UK rates peaking at 4.7% in the second half of 2023, followed by rate cuts potentially starting in early 2024. Meanwhile, US rates are expected to peak at around 5-5.25% before rate cuts commence in late 2023. All in all, the risk of a policy mistake leading to a sharper than expected slowdown remains elevated as we go through the first half of 2023.
We see a challenging year ahead. With the global economy still facing a confluence of challenges, from persistently high inflation and aggressive rate tightening led by the Fed to the continued fallout of the Ukraine war, the resulting energy crisis, weak consumer confidence and continued political disruptions, our base case is for a ‘hard landing’. Our proprietary economic activity indicators point to a continuing slowdown with recession likely in the US and near-certain in the UK and Europe.
Janus Henderson
Although we expect central banks in the major economies to continue to push through a number of rate hikes in the next few months, policy rates should peak in Q1 in the US, and in Q2 in the eurozone and the UK. Even though inflation seems likely to remain uncomfortably high for these economies well into 2023, central bank concerns should be somewhat offset by slowing growth and the recognition that the full restrictive impact of previous rate hikes will still be working through the economic system. While the prospect of easing interest rate pressures should be constructive for markets in the first half of 2023, the associated weakening of growth remains a challenge. Consensus predictions of real GDP growth for 2023 now stand at 0.4% for US, -0.1% for eurozone and -0.8% for the UK. These forecasts envision a slowdown in the US and eurozone that will be the gentlest and the shortest that could be called a recession. On balance, it is hard to avoid the conclusion that the early months of 2023 present a complicated backdrop for risk assets. Nevertheless, with most of the rate hiking cycle now behind us and with asset valuations notably more attractive that where they were a year ago, 2023 should be a better year for investment returns than 2022.
Market regimes rarely change on the turn of the calendar. The headwinds on both the interest rate and growth fronts are likely to persist well into 2023.
J.P. Morgan
In the worst-case scenario, the UK is more vulnerable than the US to a potentially deeper recession, given that there are more households on variable rate or short-term fixed rate mortgages. Much will depend on how persistent UK inflation proves and how long mortgage rates remain elevated. Our base case sees UK interest rates peaking at around 4.5% next year. We think that will be sufficient to help bring inflation down significantly although perhaps not all the way back to target. While we expect 2023 to be a difficult year for the economy, we think markets largely priced that in during 2022 and therefore think that 2023 could be a better year for markets as they start to look ahead to an economic recovery in 2024.
Our core scenario sees developed market economies falling into a moderate recession in 2023, caused by high inflation and the resulting increase in interest rates. Thankfully, the risk of a deep recession of the type experienced in 2008 is low. There has been much less subprime mortgage lending, very few Americans are now on adjustable-rate mortgages, there has not been a construction boom leading to an oversupply of housing, and the banking system is much better capitalised.
M&G
Meanwhile, we are yet to see signs of peak inflation in other developed markets, with higher food and energy costs still putting upward pressure on prices and inflation across Europe and the UK. That said, we are closer to the light at the end of the ‘rate hike tunnel’, with central banks likely to stop hiking sometime in the first half of 2023. Importantly, I don’t see any room for central banks to adopt a less hawkish rhetoric as they risk de facto loosening monetary conditions by lowering rate expectations, which in turn would make their job more difficult and potentially force them to tighten more, and for longer. We saw markets remain volatile in 2022. To move beyond this in the months ahead we’ll need a positive jolt of some description, whether that be confirmation of inflation peaking or central banks no longer hiking rates or, indeed, a resolution to the tragic war in Ukraine, and – of course – a milder-than anticipated recession.
For now, inflation remains a principal concern for investors. Recent US inflation data has shown initial signs of inflation peaking there, as higher interest rates dampen demand and supply chains recover. However, with spending rotating back to labour intensive services and the jobs market still tight, we’re unlikely to see a pronounced pivot from the Fed, so rates could remain elevated for some time.
The opinions expressed by our Global Partners do not necessarily reflect the views of Quilter Investors.
Views as at 6 December 2022.
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