Five big investing questions for 2023
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Five big investing questions for 2023

15 May
5 Jan
  • Enduring the fastest tightening of monetary conditions by the Fed in 40 years, 2022 closed off with hopes that inflation has peaked and most of the rate hikes are done.
  • Commentators see a shallow recession, or soft landing, as likely in 2023. Household balance sheets are stronger; the global housing market is more resilient post-GFC.
  • Bonds are offering attractive yields and investors can soak up more income for less risk; as for stocks, investors should watch for more earnings downgrades in Q1 2023.
  • Alternatives may stay in vogue for investors turned off by the poor performance of their 60/40 portfolios of public equities and bonds in 2022. But selection is key.

As we kick off the new year, investors may be thinking about what will shape their investing journey in 2023. Here are five big investing themes that may dominate the year.

Have we hit peak inflation?


In 2023, the focus on inflation will remain — specifically on whether US inflation has peaked, with November’s core Consumer Price Index (CPI) making its smallest advance in 15 months. (Core CPI strips out energy and food prices due to their volatility.) 

This attention to the surging consumer prices in the world’s largest economy comes because the Fed has been aggressively hiking interest rates to fend off runaway inflation. In 2022, the Fed made seven rate hikes, bringing the benchmark fed funds rate to a range of between 4.25% and 4.5% — a 15-year high. It is the most aggressive Fed rate-hike cycle in more than 40 years.

Chart: The pace of Fed rate hikes in this cycle has been rapid; change in fed funds rate (%)
Source: Schwab Center for Financial Research

Interest rates reflect the cost of capital — from an economic perspective, when credit becomes more expensive, this engineers a slowdown in growth and can cause job losses, which also cools consumer demand. 

From an investor’s point of view, it changes how stocks and bonds are valued with the sudden surge in the cost of capital — albeit from a long period of low rates. The concern is how destabilising the sudden jump in debt burden will be on asset prices. As it is, growth stocks were stung in 2022 as investors reassessed their lofty valuations, with tech firms missing earnings projections and investors turning impatient with loss-making counters. 

At the Fed’s final meeting of 2022, policymakers agreed to raise the central bank’s key interest rate by 0.5 percentage point — a smaller increase than the 0.75 percentage-point hikes seen at the previous four straight meetings. 

But hopes of a less aggressive Fed were dashed as the Fed chair Jerome Powell signalled a more aggressive rate hike path than what investors were hoping for in 2023. Some commentators suggest that the Fed may now be overshooting on inflationary expectations, after undershooting on the previously held belief that inflation was transitory. 

Chart: Prevailing downside risks; Risk of excessive Fed tightening seen as top risk for 2023; inflation fears dissipate, global profit recession, global slump or EM debt crisis, China recession, are among other risks
Source: Amundi poll. Data as of 23 Sept 2022.

At this point, there are two tracks when it comes to looking at inflation. While goods inflation (houses, cars, capital goods) has come off significantly in the later part of 2022, inflation in the services sector remains stubborn, as people continue on their revenge travel and spend more at restaurants and concerts after some two years of Covid-prompted social distancing. 

Chart: Inflation in the service sector, which accounts for 80% of GDP, has been especially stubborn, as compared to goods sector inflation
Source: Apollo

A lot of attention falls on how much US unemployment will need to rise to let out some wage-inflation pressure. PIMCO points out that the post-pandemic labour market has changed in fundamental and complex ways: “There has to be a great deal of uncertainty as we enter 2023 about how much adjustment in the labour market will ultimately be required to reduce wage inflation to a pace consistent with price stability.”

In its investment outlook for 2023, BlackRock sees central banks eventually backing off from rate hikes as the economic damage becomes reality. That said, while inflation will cool, it will stay persistently higher than central bank targets of 2%, it adds.

Chart: Taming inflation would take deep recession; getting inflation all the way back down to target would require the Fed to deal a significant blow to the economy
Source: BlackRock

There are three main reasons for this:

  • Ageing populations mean continued worker shortages in many major economies.
  • Persistent geopolitical tensions are rewiring globalisation and supply chains.
  • The net-zero transition brings on supply and demand mismatches.

Against this backdrop, BlackRock notes that investors need to come to terms with a new investing playbook. “Central bankers won’t ride to the rescue when growth slows in this new regime, contrary to what investors have come to expect,” it says. In fact, they are deliberately engineering recessions by overtightening policy. 

“That makes a recession foretold.”

Which brings us to the next question — how painful will this impending recession be?


Recession: a soft landing?

Fidelity sees a shallow recession as likely. The view is that the US Fed tightening would push the economy into a cyclical recession, but an eventual pivot by central banks combined with stronger balance-sheet positions in developed markets could cushion the shock, preventing a severe downturn.

Charts: The historical relationship between tightening financial conditions and the economy suggests a deep contraction is ahead, but the strength of balance sheets makes us more sanguine.
Source: Fidelity

Similarly, JPMorgan Asset Management’s core scenario sees developed economies falling into a mild recession in 2023. Its view is that far more expensive mortgage rates will crimp new housing demand, with the impact felt through the global economy in 2023. This means weakening construction activity, and less spending on furniture and other household durables. The wealth impact from falling house prices could also weigh on consumer spending for the next few quarters. Taken together, these should have the intended effect of taming inflation.

The impact should also come without a deep and painful economic contraction (as was seen in the Global Financial Crisis, or GFC). There is less of a supply glut this time round, as seen in the chart below detailing the situation in the US and UK. Global regulators — including those in Singapore — have also tightened borrowing rules to ensure prudence by borrowers. 

Chart: Housing inventories in the US and UK; limited stock of housing for sale should prevent large declines in house prices
Source: JPMorgan Asset Management


Bonds are back; will it vindicate a 60/40 balance?

Balance - 60/40 investment portfolio of stocks and bonds

For the first time in a long while, investors are getting excited about bonds. 

To be sure, the bond market went through a shock, given the fastest pace of rate hikes seen in modern times. For the first time in 45 years, both stocks and bonds fell in tandem in a calendar year, in 2022. 

Chart: Stocks and bonds rarely decline in tandem; MSCI World Index and Bloomberg US Aggregate Index annual total returns (%); but in 2022, both declined.
Source: Capital Group

But as a research note from Schwab points out, the bond market today is now offering attractive yields not seen in years. 

With most of the Fed’s rate hikes behind investors, and with inflation likely to fall, yields in fixed-income solutions are today above dividend yields. And with risk-free government bonds offering stronger yields, investors can soak up more income for less risk. 

Given recession fears, high-quality fixed income does well in this scenario, says Capital Group. While rising rates have caused bond prices to fall, this also means yields are rising. Particularly for holders of bond funds, income should increase; once the bonds in the funds mature, the funds are reinvested by bond managers into fixed income with higher yields. 

Table: Yields of key fixed income markets have soared across asset classes; including the Bloomberg US Aggregate Index, investment-grade corporates, high-yield corporate credit, and emerging markets debt
Source: Capital Group

Reports of the 60/40 death are greatly exaggerated

Long live the balanced portfolio — so declares Eastspring Investments

While investors may wonder if tactical shifts would make more sense in this environment, the fund manager notes that over the long term, the balanced portfolio is likely to outperform a market timing strategy that tries to switch between equities and bonds — even before accounting for transaction costs. 

To illustrate this, Eastspring calculated what would happen if an investor tried to time the market every month between 1992 and 2022 — meaning a full switch between equities and bonds. At the end of 30 years, the market timing strategy would have ended up below the 60/40 portfolio in 58% of the cases. 

This comes before any transaction cost, which can, in reality, be substantial. If a modest transaction cost of 0.1% of the value of each trade is included, then the 60/40 portfolio would have beaten the market timing strategy 90% of the time over the course of 30 years.

Chart: The paths of a market timing strategy vs a 60/40 portfolio of stocks and bonds; market timing is hard, and the alternative is to stay invested in a fixed proportion throughout. Over the long term, the balanced portfolio is likely to outperform a market timing strategy.
Source: Eastspring Investments

“As the historical bond and equity relationships are being re-asserted following the market corrections this year, the stage is set for the balanced portfolio to deliver the long-term returns that investors desire, with the volatility that they are comfortable with,” Eastspring concludes. “It is too premature to call for its demise.”


Still bearish on stocks till earnings adjust?

Allianz Global Investors’ (AllianzGI) 2023 investment outlook notes that corporate earnings expectations still need to adjust downwards — possibly by a large margin in some cases — as they have not yet fully priced in the recessionary environment, rising inventories, input costs and rates, as well as a stronger greenback.

“Expectations need to adjust to a world in which money has a cost again,” it adds. “Growth can no longer be funded with limitless debt, and the threshold for the return on capital employed must rise. Ultimately, this development is healthy and may promote the survival of the fittest, favour quality companies and balance sheets, and boost income for some.”

Chart: Corporate earnings; after the massive earnings-per-share (EPS) rally in 2021, earnings expectations for 2023 and 2024 are looking downbeat, but may adjust further.
Source: AllianzGI
Chart: Consensus points to a divergence between S&P 500 earnings and GDP growth expectationsc
Source: Apollo

Commentators therefore will be looking to the upcoming earnings season, with listed companies due to report their 2023 guidance in the first quarter of the year. Morgan Stanley expects the emerging markets to be early to the recovery on cheap valuations and a typical recovery before the US markets — if the previous economic cycles offer a guide.


Will the alternatives rock on?

The Nirvana reference goes beyond a riff on the term “alternatives”. 

Music from the band synonymous with the grunge movement is also owned in part by a private equity (PE) group. More PE firms have in recent times snapped up music royalties of top acts such as Red Hot Chili Peppers, Justin Bieber, and Taylor Swift (much to her chagrin).

PE joins hedge funds, private credit, and other forms of alternative investments as a touted way to add diversity to one’s investment portfolio. This is particularly so for those who believe the balanced portfolio no longer offers diversification benefits.

In its outlook, Apollo says that investors who were stung by a poor performance from their 60/40 portfolios of public equities and bonds in 2022 are likely to turn to private markets in 2023. “Purchase price matters and we see a historic entry point in private credit and attractive opportunities in private equity for investors able to be providers of capital in a time of stressed and distressed markets.”

PE proved particularly resilient during the GFC, noted by some as the first real test for the investment class. Data from Preqin shows that the S&P 500 was hit by a maximum drawdown of some 40% between 2008 and 2009. PE, however, was down by just 26.6%, as measured by the Preqin Private Equity Quarterly Index (PrEQIn).

Chart: Private equity drawdown vs S&P 500 drawdown, from 2008 to 2022
Source: Preqin

That said, Preqin points out that the circumstances of the market today reflect different pressures, specifically with inflation and rising rates — this is an unprecedented test for the asset class. 

Global macro hedge funds in 2022 also had a blowout year, making trades off swiftly shifting rates and currency moves. But selection matters: the biggest gap between the best and poorest performers (by top and bottom deciles) since the GFC was also recorded in 2022.


For a wrap-up of 2022’s biggest market events, follow this link

With digital wealth platform Endowus, you can plan and manage your money — by investing in carefully curated funds, in globally diversified, intelligent and low-cost portfolios seamlessly. To get started with Endowus, click here.



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