How will markets do in 2023?
War in Ukraine, China’s recovery and inflation are all likely to have an effect
The primary outcome that investors in equities are purchasing is a long-term stream of earnings and earnings growth.
The caveat is that in the short and intermediate term, these earning streams and their valuations get very noisy. Writing about market prospects for the year ahead risks surmising about something both short term and messy. The merit of such analysis is hopefully to guide a measured behavioural response to events. Markets can fall in expectation of negative earnings growth due to recessions, but then rebound in expectation of recovery from such recessions.
The US is the world’s dominant market. Its inflation numbers are concerningly high but falling, and interest rates are rising off an extremely low base. Inflation is affected by cyclical elements that are now rolling over (for example oil, energy and food prices), but other factors, such as excessive prior money printing, deglobalisation and full employment, could aggravate inflation. January’s encouraging 6.5% inflation number is still higher than interest rates, so inflation must either continue to fall or interest rates must rise.
The US Federal Reserve doesn’t like to cause recessions, but is prepared to generate one if inflation persists in looking sticky. The reason is that if inflation stays persistently high it brings about distortions in the normal economic pricing mechanism and the long-term costs of government borrowing will skyrocket (relevant after so many years of near 0% interest rates).
Current US data sets make for some conflicting thoughts. GDP for Q4 2022 was positive, and the Atlanta Fed’s GDP nowcasting tool suggests firmer GDP for Q1 2023 than consensus. Paradoxically, this positive data would be received negatively by the market because it would flag to the Fed that the economy could tolerate aggressive rate hikes. The current “inverted yield curve” contradicts this. The two-year US government bond yields 4.1%, and the 10year bonds yield 3.6%. A curve shaped like this typically indicates weak growth ahead. During 2022, recession was repeatedly flagged for the US and was the primary driver of last year’s weakness. This may be the most confidently expected recession ever, and so is well embedded in current market prices.
US bonds offer their highest coupons in (say) the past 10 years. However, they are still negative real yielding assets though less awful than fixed income in other Organisation for Economic Co-operation & Development (OECD) countries.
This inflation-and-growth dynamic might be a worse problem in Europe. The impact of energy prices and the Ukraine war on European economies caused higher inflation and a worse GDP fall than in the US. EU shares are bombed out, but seem likely to stay that way for quite some time.
One of the most important global offsetting events is the long overdue reopening of China. The “Covid restrictions” choked global supply chains and deprived the world of China’s large contribution to overall global GDP growth. As we have seen before, economic recovery from lockdowns tends to be big, and this should be the case for China in 2023. There’s some relaxation by Chinese authorities of their hostile attitudes to free markets, but investor trust has been lost. Chinese recovery would support commodities, and hence the South African economy.
Political analysts say
President Cyril Ramaphosa was strengthened by the outcome of the recent ANC elective conference. A most positive outcome was that of improved succession in new deputy party president Paul Mashatile. The president seems encumbered through being beholden to the support of several factions. The reforms necessary to critical institutions (such as Eskom and Transnet) that are essential for a commoditybased economy remain a wish list, while crime and corruption grow off their high base. Thus the primary merit of any South African listed shares must be either their gearing to offshore earnings or their ability to operate in spite of government bumbling.
A recession in the US seems highly likely; however, such an event seems well discounted, and the current levels seem fair for buying, notwithstanding elevated volatility looking likely.
The EU is most likely a value trap; possibly Japan and the UK offer some value among other OECD markets. Recovery in China could very well drive both resources and other emerging market economies, but our willingness to trust in China’s economic good behaviour has substantially diminished.
Sadly, South Africa Inc could be a value trap if the domestic energy shortage isn’t mitigated.
One of the most important global offsetting events is the reopening of China