We would like to share with you some slides from our recent Investment Committee presentation, which discussed the investment outlook for 2023. Forecasts are usually revised several times throughout a year, but for now we see the world developing as below.
1. We start with the latest developments with regard to interest rates, inflation as well as global geopolitical issues.
Summarizing, one can say that most of the monetary tightening (higher interest rates) are behind us while the peak of inflation has most likely been passed. Good news from Europe (with respect to the energy crisis) and China (with respect to their Covid19 strategy) are worth mentioning.
2. There are three major issues that we should have in mind.
We are expecting economic growth to slow down, which should also bring inflation down. However corporate earnings, especially in the US, seem still too high, and a potential downgrade should take place in the first quarter of 2023.
3. The difference between the 2-year and 10-year yield in the US point to a recession.
The green line shows this difference which is now negative and at the lowest level of the last 30 years. The grey areas represent recession periods, which means that almost always after such an inversion of the yield curve (the 2-10 years being negative), a recession has followed in the coming few months.
4. The US housing market is always in a recession.
The NAHB index on the left has just collapsed, as activity has come to a standstill due to the combination of very high mortgage interest rates and high house prices. At the same time, home prices have finally started to come down, which is good for inflation.
5. The US consumer's savings have collapsed.
The blue line shows the ratio of savings vs the disposable income of the US consumer. One can see the explosion of savings during 2020 and 2021 as governments were subsidizing citizens and our expenses had fallen significantly as travelling, going-out to restaurants etc was curtailed due to lockdowns and fear from catching the virus. But this has dramatically reversed in 2022. The consumer's savings are now very low compared to their income as high prices and their previous consumption habits are biting them. This is bad for the economy and good for inflation.
6. Inflation has already started to moderate.
In the US, the rate of monthly change of inflation has already started to moderate. To make an analogy with Covid19, the "curve has started to flatten". We also note the "base effect", which in statistics means that to arrive to the annual inflation in 2023, one will have to compare with already high prices, which puts a natural dampener on how higher inflation can move.
7. A mathematical simulation shows that inflation could fall sharply in summer of 2023.
Taking the average monthly increase of inflation in the US, which was 0.2%, and applying it for the next several months, we arrive at the below result for annual inflation. It is impressive that despite assuming that prices will continue to move higher, albeit at a more moderate pace than the start of 2022, annual inflation could fall to around 2%, which is the FED's target before the end of next year. This is not a macroeconomic forecast, but just a mathematical exercise.
9. Our view on the various asset classes is constructive.
Bonds, especially high quality and government bonds, should offer very good returns in 2023 under most scenarios, including that of a deeper than expected recession.
Equities have already discounted part of the recession, especially in Europe. Valuations should begin to move higher (in terms of P/Es) which should support the simultaneous drop in the companies' earnings. Hence, although we are not fully invested we are not overly negative. Defensive sectors and quality companies should do well.
Gold should finally be a beneficiary of an environment of low growth, higher than usual inflation and favorable demand/supply dynamics.
10. We take the opportunity to wish you a healthy and prosperous new year,
Investment returns should follow too.
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Sources of the charts : Factset, if not otherwise mentioned in the chart.