The start of 2023 has been generally positive for markets. While the rally has been a welcome relief from the tumultuous market environment in 2022, the key question is whether the recent rally has legs or whether it is simply a bear market rally with more volatility to follow as we progress into 2023.
The market has been skittish over the past 12 months with any positive news on the inflation front, such as any sign that inflation is moderating, resulting in the market to rally. While the most recent rally has partially been driven by some evidence that we are closer to reaching peak inflation, we have also seen liquidity pumped into the market which has not doubt supported market returns. Central banks have been generally decreasing their balance sheets with key central banks such as the US Federal Reserve moving from a quantitative easing policy to a quantitative tightening policy, which has reduced the overall liquidity that’s supporting markets. But we also have seen some central banks, notably the Bank of Japan (BoJ) and the People’s Bank of China (PBOC), add liquidity to markets in recent months, which markets have liked. However, we do not believe that this trend is structural and that the direction of inflation and potential impact on economic growth will be the key driver of markets as we progress throughout 2023.
Our base case remains that the third quarter of 2023 will be ‘d-day’ for markets as the direction which company earnings will take, due to the impact of higher interest rates, will be clearer. The most recent company reporting season suggests that there is evidence of slowing in demand, however this is not consistent across all sectors and companies.
Overall, we believe that market returns may trend sideways for the full year with a possible downturn later in the year. In such an environment being able to pick out the ‘winners’ from the ‘losers’ will be increasingly important as simply riding the broader market to generate returns will be more challenging.
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