Annual outlook 2023
Weak financial markets, inflation, energy crisis and geopolitical flashpoints – the year 2022 was full of challenges and disappointing from an investor’s point of view. All the more reason to take a breather and recharge your batteries “between the years”. Looking ahead to 2023, too much pessimism is just as inappropriate as naivete. In the following, we outline our thoughts on the macroeconomic outlook and the prospects on the markets.
USA: Recession – not whether, but when
Talk about the R-word has been making the rounds for months now. If the USA slips into a recession in 2023, it would arguably go down as the most anticipated economic downturn in history. According to the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters, almost half of the economists questioned expect to see a recession within the next twelve months, a forecast seconded by a whopping 85% of respondents to a December survey conducted by the Financial Times. Wall Street analysts currently place the probability of a recession at around 60%. In fact, so much statistical evidence has accumulated by now that a recession no longer appears to be a question of whether one will occur, but when it will happen. The most prominent warning signals include the US yield curve, which has already been inverted for weeks now (i.e. short-term market interest rates are higher than long-term yields), a condition that in the past has portended a recession within six to 24 months with almost 100% reliability. Other data points such as the Conference Board’s index of leading economic indicators, the US purchasing managers’ index and initial unemployment claims are singing the same tune. The subdued price of oil despite the tight supply situation can also be interpreted as a precursory sign of weakening economic activity.
The effects of the US Federal Reserve’s rapid rate-hiking campaign are the primary cause of the mounting headwinds facing the US economy. Now that those effects have already impacted areas of the economy that are particularly sensitive to changes in interest rates (e.g. the housing market), the restrictive monetary policy is soon likely to be felt more broadly throughout the economy. Viewed superficially in terms of new job creation, the US employment market stills appears to be booming. But more and more signs of weakening are becoming discernable, be it granularly in the drop in the number of unfilled jobs or more conspicuously in mounting layoff announcements. The pathway to central bankers’ desired scenario of a soft or at least a softish landing is extremely narrow in any case. Raising unemployment just enough to tame inflation would be the goal. But in the past, a 0.5-percentage-point rise in the unemployment rate has consistently been enough to tip the economy into a recession. In its December forecast, the Fed projected that the jobless rate would climb to 4.6% by the end of 2023 from its previous low of 3.5%.
The historical facts are inescapable, so we, too, anticipate a recession, but a little later rather than sooner, namely in 2024. Consumers might be able to keep US economic activity, which is particularly driven by consumer spending, above water for a few quarters more until then. Real wages look set to resume rising in 2023 on the back of receding inflation. Meanwhile, excess savings from the pandemic have not been depleted yet. And job openings continue to outnumber job seekers, which should slow an increase in unemployment for the time being. When a recession then comes to pass sooner or later, we expect it to be a comparatively mild one because in contrast to the last two recessions in 2001 (caused by the burst dot-com bubble and soaring consumer debt) and in 2008/2009 (caused by the housing market crash and the ensuing financial crisis), this time there are no similarly severe macroeconomic imbalances of that kind in play.
A compelling case… | …for a recession?
Percentage of survey respondents anticipating a recession in the next twelve months
Sources: Survey of Professional Forecasters (Federal Reserve Bank of Philadelphia), Kaiser Partner Privatbank
Europe: Hoping for a warm winter
Unlike in the United States, a recession in Europe is a sure thing, at least on average in the EU and in some countries like Germany, Italy and the UK that have been hit particularly hard by the energy crisis and/or by rampant inflation. The worst fears, however, appear not to be coming true. The downturn could at least turn out milder than was feared in autumn and might stay limited to an aggregate economic contraction of less than one percentage point for the Eurozone, thanks not only to the comfortable natural gas storage fill level in the EU, but also to the adaptive ability of companies in most industries to reduce their gas consumption without curtailing production. The extensive government aid packages also buttress economic activity by making sure that high energy prices do not tear too big a hole in consumers’ wallets, by keeping unemployment at bay and by averting a tsunami of corporate insolvencies.
Nevertheless, consumer and business sentiment arguably won’t lastingly brighten again until temperatures warm up in spring. Then a broad recovery might unfold in the second half of 2023, likely driven by pent-up consumer and investment demand, expansive fiscal policies and a resurgence of the export sector. But the weather forecast will remain more relevant than usual in the months ahead, and not just for small talk around the office coffee machine. A mild winter would be desirable, also as a means of securing a good starting position for the 2023/2024 winter season. Anyway, the challenges remain tough enough as is given the ongoing soaring prices for natural gas and electricity. Be that as it may, there will be no going back to cheap Russian natural gas. However, the forced acceleration of the green energy transition also harbors opportunities for Europe.
Downward | Growth expectations in correction mode
Consensus economic growth estimate for 2023
Sources: Bloomberg, Kaiser Partner Privatbank
China: The last wave
Better late than never – the end of China’s zero-COVID policy was ultimately inevitable. But it did come as a minor surprise that it is being rolled back during the winter (at the worst conceivable time). As so often happens, China is following its own rules, this time in an untidy and chaotic manner. Many COVID restrictions have already been eased, and the last of them may be rescinded by the end of March. Since PCR testing has largely been discontinued, China’s official COVID-19 case count has long become detached from reality. However, estimates can be derived from experiences in other countries in Asia, which indicate that the wave of daily infections in China could rise to as high as 10 million in January and will probably crest in early February after the Chinese New Year celebration. This gives reason to expect yet another dip in economic activity in the first quarter of 2023. Not only are there bound to be renewed supply-chain disruptions, but personal consumption is also likely to suffer because many Chinese will hold off on spending and engaging in activities out of fear of catching the virus. The number of deaths could swell to more than a million, but is unlikely to be disclosed transparently by the government. If developments follow the typical coronavirus pattern, this “last wave” will be over in April.
However, the economic element of surprise for the second quarter and the remainder of 2023 lies on the upside because forceful pent-up demand effects look destined to spark a small burst of growth then. Goldman Sachs estimates that the zero-COVID policy reduced China’s gross domestic product by four to five percentage points. The reopening of China’s economy could have a boosting impact almost of the same magnitude and could reverberate worldwide. Since China accounts for around one-fifth of the world’s economic output, the end of “zero-COVID” could boost global growth by up to one percentage point – a growth dividend that is not factored into the current muted consensus forecasts. However, the end of pandemic restrictions will not solve every problem. China’s real estate market in particular continues to face a tough situation. The government of China will therefore support the economy with carefully dosed fiscal and monetary policy measures in the months ahead. Public authorities, for example, will probably continue to help out struggling real estate developers. Lending growth looks set to pick up over the course of 2023. We could see a return to growth rates north of 5% in China in 2023 at least for a few quarters.
No testing… | …no discovered cases
Daily COVID-19 infections
Sources: Our World in Data, Kaiser Partner Privatbank
Inflation: Back on the ground – but where is that located?
Inflation is on the retreat, no longer just in the USA (and Switzerland), but also in the Eurozone lately. This ebbing process looks set to continue in the months ahead, probably faster than most people think it will. Just as inflation jolted financial market participants, businesses and consumers in 2022, disinflation could pleasantly surprise those protagonists in 2023. The United States continues to set the pace here. Year-on-year inflation rates there are already negative for many components of the consumer goods basket (for items such as energy and durable goods like used cars). The annualized three-month inflation rate is likewise already below the zero line when housing rent is stripped out. Rent price growth is currently still a major inflation driver in the official statistics, but only because of a design-related six- to twelve-month time lag. Housing rents in reality are already falling at present and likewise look set to become a disinflationary factor in the second half of 2023 at the latest. Indicators such as agricultural goods prices, inventory stockpiles and freight shipping rates also point to disinflation. We do not rule out a scenario in which inflation in the USA already pulls back close to the Fed’s 2% target toward the end of the year, but that does not jibe with the consensus view (yet) at the moment. The Fed itself would be surprised at such a development. It currently projects a core inflation rate of 3.5% for end-2023!
We henceforth are also likely to see continually falling inflation rates in Europe. Eurozone inflation might at least move into close proximity to the 3% mark toward the end of 2023. But despite the favorable near-term inflation outlook, we are sticking with our strategic stance, which holds that in the longer term, the era of persistently low inflation below 2% is probably over (including in the Eurozone). The shrinking labor force, rising costs for climate protection and reduced dependence on Russian energy resources, the structural shift toward non-automatable services (e.g. in the healthcare sector), deglobalization, and an expansion of (less efficient) state industrial policy foretoken a somewhat higher rate of inflation in the 2%–3% range in the future. Whether there will be a second inflation wave in 2024 and 2025 after the impending disinflation phase in 2023, similar to what happened in the 1970s, is another story. It at least is a risk, one that is likely to mainly preoccupy US central bankers at the moment.
From price driver to price suppressor | The falling price of oil calms nerves and price statistics
Crude oil price
Sources: Bloomberg, Kaiser Partner Privatbank
Monetary policy: On the verge of the next mistake
The autumn rally on equity markets (which eased monetary conditions and counteracted the Fed’s tightening policy) was doubtfully to US central bankers’ liking. And a renewed inflation rollercoaster ride like in the late 1940s or in the 1970s is also hardly in the Fed’s interest. The Fed’s statements at its last press conference, which set the course for the weeks ahead, were thus accordingly hawkish. The Fed at first looks poised to raise the federal funds target rate to 5% or higher in the first quarter of 2023 and then is likely to leave it in ultra-restrictive territory for a lengthy period of time. However, the “neutral” rate of interest that is neither too high (suppressive) not too low (stimulative) for the economy is more likely in the neighborhood of 2.5%, according to the Fed’s own estimate.
So, on the heels of the first monetary-policy mistake – i.e. waiting far too long until early 2022 to raise the interest-rate level – a second error now looms, that of overtightening beyond the slim chance of a soft landing and straight into a full-blown recession. Soft landings are tough to engineer in any case, particularly due to the long lag time between cause (rate hikes) and effect (weaker economic activity). Nine out of twelve rate-hiking cycles since the end of World War II ended in a recession. The aforementioned lag time means that the effects of the numerous oversized rate hikes implemented by the Fed in summer and autumn 2022 won’t show up in the broad economy until spring/summer 2023 at the earliest. Not until then will the “harm” inflicted on the labor market become visible in the form of a higher unemployment rate and a slowdown in wage growth. So, Fed Chairman Jerome Powell actually should lean back now and leave interest rates at their current level and let time work for him. He’s much more likely, though, to overtighten the interest-rate screw. The financial market also doesn’t believe that the Fed will avoid making a monetary-policy mistake 2.0 or will succeed in engineering a soft landing. Quite the contrary, in fact, interest-rate futures are pricing in a reversion to rate cutting by as soon as the second half of 2023. For that to become a reality, the macro picture would have to deteriorate rapidly in the weeks ahead. We are a bit more optimistic at least about the timing of the next recession, as we described above.
European Central Bank President Christine Lagarde also sent a stern message to the markets in December. Not only did she sound the starting gun for a (passive) reduction of the enormous bond holdings on the ECB’s balance sheet, she also signaled that several more 50-basis-point rate hikes – much more than the market is anticipating – are on the agenda in the near future in view of persistent inflationary pressure. The ECB doesn’t see inflation returning to its 2% target until the fourth quarter of 2025 at the very tail end of its forecast horizon. So, a lot of work – i.e. an even more restrictive environment – is needed to get inflation down to that goal. If the ECB follows up its words with deeds, this would weaken the Eurozone economic recovery sketched out above in the second half of 2023 or might even forestall it completely. Meanwhile, the monetary-policy course charted by the Swiss National Bank is less volatile than the path being pursued by SNB officials’ colleagues in Frankfurt, though admittedly the SNB is facing a smaller inflation problem than the one confronting the ECB. The policy interest rate in Switzerland could reach the top of the flagpole by as early as March after one further hike to 1.5%. However, the SNB enjoys the luxury of having an additional powerful means of combating inflation in its arsenal because it has the possibility to engage in further foreign-currency selling to strengthen the Swiss franc.
Not over yet | Further rate hikes in sight
Policy interest rates
Sources: Bloomberg, Kaiser Partner Privatbank
Equities: When everyone expects a check mark
Year in and year out, the same old game is observable on Wall Street. In early December, analysts present their stock outlooks for the next year. This time, though, their presentations frequently contained a “Nike-Swoosh” – a check mark intended to graphically represent a dip in stock prices in the first half of 2023, a cheap entry point at mid-year and a subsequent rally. The matching narrative is mounting recession concerns and falling corporate earnings followed by hopes of monetary-policy easing and ultimately by an about-face by the US Federal Reserve in the second half of 2023. In this scenario, many analysts view the 3,100 to 3,400 range for the S&P 500 index as an opportune entry point. This raises a question, though: If all of those bears are proven right and want to buy at a level of 3,250 points, who will sell them stocks? At a level of 3,250 points, the markdown from the S&P 500’s peak level would amount to around one-third (in nominal terms), mind you, and would even be 40% off when adjusted for inflation. At that point, the only investors left on the sellers’ side are likely to be those who expect to see a brutal recession. Earnings expectations do, in fact, look set to get revised further downward a bit in the near future, but estimates (excluding the energy sector) were already lowered by more than 12% over the course of 2022. If a recession doesn’t occur in 2023, earnings forecast cuts could remain limited to 15%–20%. Stronger-than-expected economic activity could actually even spur a return to upward earnings revisions soon. That would catch many analysts on the wrong foot.
In any event, analysts are not particularly optimistic judging by their price targets for the S&P 500 index. Year after year, the analyst community usually forecasts more or less a 10% increase in the US blue-chip index, which is certainly understandable given the long-term tendency for share prices to rise. But things looked different for once in December 2022. Analysts on average envisaged only flat share prices, which tends to be a good omen from a countercyclical (sentiment) perspective. So, it’s quite conceivable that the “check mark” scenario won’t come to pass and that the 3,100-to-3,400-point index level desired by the majority won’t be reached, at least not so quickly. However, despite our mildly less negative near-term view, we believe that we’re in the midst of a protracted bear market that hasn’t reached its definitive bottom yet. Bear markets typically bottom during recessions. This means that the current bear market may not bottom until 2024 in the more favorable macroeconomic scenario.
In any case, an array of macro indicators will first have to further deteriorate considerably before the final selloff can be verified. During the last five recessions, for example, the weekly number of initial claims for unemployment benefits in the USA stood at no less than 400,000 (today: 230,000) and the ISM purchasing managers’ index reading was below 44 points (today: 49 points). The yield curve had already reverted back to a positive slope of at least +50 basis points (today: 60-basis-point inversion), and the Fed had lowered its policy rate by at least 2 percentage points (today: the federal funds rate hasn’t peaked yet). This illustrates how long the remaining road may be until the end of the bear market. For investors, this means another “fat and flat” year with a lot of volatility and most likely only a meager return on the bottom line. This market climate could last for several more years. Good diversification across regions and sectors – without any big individual bets – and a focus on blue-chip stocks is the right strategy for facing this vexing environment. Investors also should continue to refrain from wanting to try to time the market even though the high volatility makes the temptation to do so very alluring, because the adage that “chasing returns leads to the poorhouse” also goes for 2023.
Missing optimism | Analysts’ price targets are conservative for a change
Year-end targets for 2023 (S&P 500 index)
Sources: Bloomberg, Kaiser Partner Privatbank
Fixed income: A bird in the hand…
…is worth two in the bush. Investors may start earning money again with “boring” but safe fixed-income assets in 2023. Government bonds were still an interest-free risk back in summer 2021, but today they are an interest-bearing, purchasing-power-boosting (positive real yield) hedge against an economic downturn. The fastest rate-hiking cycle in more than 40 years has flipped the yield landscape completely upside down in the span of a few quarters. Investors must now totally reevaluate the attractiveness of the various asset classes and can start to climb back down the risk ladder. Investors no longer necessarily have to hold risky technology stocks to earn a solid investment return – bonds issued by blue-chip companies with good credit ratings can also generate equity-like returns over the next 12 to 18 months.
At a time when investors are increasingly thronging into private markets, as they have been lately, the traditional public fixed-income market isn’t the only thing experiencing a comeback. (Government) bonds also soon look set to regain their risk-reducing effect on mixed-asset portfolios. The performance correlation between stocks and bonds was positive in 2022 and resulted in both assets classes posting substantial losses, but correlations now look poised to turn negative again at least in a recession scenario. This means that safe bonds should resume exerting a beneficial buffering effect on overall portfolios. Even the most speculative fixed-income category – high-yield bonds – will become interesting this year. An extraordinarily asymmetric opportunity, in fact, is taking shape in the high-yield space, which is offering the prospect of equity-like returns at only a third of the volatility of the equity market. Although credit spreads at the moment (approximately 450 basis points in USA) are not yet at the level seen during previous crises, they are already compensating investors for an elevated implied default rate. If spreads widen to above 600 basis points in the months ahead, the historically earned minimum 12-month return climbs to almost 10%.
Back to normal | Positive interest is back
Bloomberg Global Aggregate Government TR Index yield
Sources: Bloomberg, Kaiser Partner Privatbank
Currencies: An expensive greenback
The US dollar was king on the currency markets in 2022, at least for the first nine months of the year. Significantly widening interest-rate differentials versus other currencies were the biggest driver of its buoyancy. In late September, the dollar’s high-altitude flight culminated in a (final) bout of panic buying and a converse selloff of the euro (energy crisis) and the British pound (crisis of government). The greenback has lost some ground since then, however, not only because inflation in the USA already passed its peak in autumn, but also because central banks in Europe in recent months have increasingly committed themselves to combating inflation and now have the monetary-policy momentum on their side. The dollar bull market, which may have ended in autumn, lifted the US currency to a very overpriced valuation level 20% to 30% above the greenback’s “fair” value, depending on the model consulted. Deviations of that magnitude can exist for long time, but when deviations are that high, the air historically becomes thin with high reliability and the forces of mean-reversion eventually take hold, pulling the valuation back to the middle of the long-term range.
A contrary movement of that kind typically persists over the longer term. This means that the euro could at least climb back to a level of 1.20 to 1.25 against the US dollar over the next three years. A bottoming of global growth expectations, subsiding geopolitical tensions (particularly in the Ukraine conflict) and rate cuts by the US Federal Reserve, which would narrow interest-rate differentials to the detriment of the greenback, would be potential drivers of a solidification of the trend reversal that probably has already started. However, trends that have been entrenched for years don’t reverse course in a matter of weeks. It’s quite possible that the dollar – amidst a further dimming of near-term global economic growth prospects and an emergence of local recessions – could first take renewed aim at its previous highs and form a double top there in the best case.
The Swiss franc was once again extremely robust in 2022 and in the end posted only a low single-digit percent loss against the US dollar for the year. The franc looks destined to remain strong in 2023 as well. Although the Swiss National Bank remains a misfit in a global comparison of central banks (excluding the Bank of Japan) with its policy rate below 2%, (nominal) interest rates alone aren’t the clinching factor for the Swiss franc – real interest rates are more relevant. The franc is not a low-interest currency at least in this respect. According to the principle of purchasing power parity, comparatively low inflation in Switzerland is what causes the “fair” nominal value of the franc to continually rise against the euro and the US dollar over the long term. The franc’s tendency to outperform during economic recession phases is another factor that works in favor of Switzerland’s currency from a shorter-term perspective. We therefore do not expect the EUR/CHF and USD/CHF exchange rates to lastingly climb above parity in 2023.
Is the bull market over? | It may have already topped out
US dollar index
Sources: Bloomberg, Kaiser Partner Privatbank
Alternative assets: A reality check
Private-market assets in 2022 once again lived up to their reputation of delivering stable returns and lower volatility. With the exception of venture capital and growth funds, private equity managers on average hardly took any valuation writedowns on their portfolio companies despite high double-digit percent losses on equity markets. Real estate strategies even posted significant gains again in the first half of 2022, but then became victims of their own success – a number of investment vehicles found themselves forced to limit share redemptions when too many investors became intent on taking profits. Looking ahead to 2023, many private-market managers are exuding confidence that the discrepancies between public and private markets may persist. We, however, anticipate that the tough macroeconomic climate will lead to a further threshing of the wheat from the chaff among private-market managers. Many funds probably won’t be able to circumvent valuation writedowns. At the same time, though, there are bound to be very good opportunities on the secondary market in 2023 because many institutional investors are overweight in private equity as a result of the outperformance of their investments and are thus forced to scale back their exposure. Those secondary-market transactions are likely to take place at substantial discounts in the quarters ahead and present attractive entry points for buyers. Private-credit strategies in particular also look set to be especially interesting in 2023. Due to their variable rate of interest, private-credit strategies benefit not only one-to-one from higher central bank policy rates, but also from the rise in risk premiums. Moreover, they have proven their defensive nature during previous economic downturns.
Soaring inflation and multiple (geo)political crises – this difficult environment should actually have been a time for the price of gold to glitter. But in the final reckoning for 2022, the yellow precious metal ended up right where it started the year (at least in US dollars, its performance in other currencies looked better) even though demand for gold was as high as perhaps it has ever been in history. Central banks alone bought 400 tons of bullion in Q3 2022 – a record volume since official quarterly tracking started in the year 2000. Demand for gold coins and bars also increased among private investors in both industrialized and emerging-market countries. But all of that lent little buoyancy to the yellow metal. The crash in cryptocurrencies – the purported alternative to gold – also didn’t help much. Instead, 2022 once again plainly revealed the true identity of the strongest drivers of the price of gold: the US dollar and (real) interest rates. They both rose sharply over the first three quarters of the year and not only made gold cheaper from a purely mathematical standpoint (calculated in US dollars), but also less attractive than interest-bearing assets. In the new TARA world (a world in which there are reasonable alternatives), not bearing interest is arguably the biggest shortcoming of the precious metal. A key group of buyers – institutional investors – has been shunning gold lately precisely for this reason. Gold ETFs have been registering substantial net outflows for more than a half-year. Looking ahead to 2023, though, the prospects for gold may now start to brighten. A Bank of America survey of fund managers found that a large number of institutional investors consider gold to be undervalued. If the worst-case macroeconomic scenario of a recession coupled with an about-face by the Fed comes true in 2023, gold could start to glitter again for once. During previous economic downturns, gold was frequently a stabilizer of asset portfolios. It delivered positive returns in five of the last seven recessions.
A buying opportunity? | Fund managers think gold is too cheap
Sources: Bloomberg, Kaiser Partner Privatbank