Over the course of 2022 our message to investors has been simple. Markets are in a period of transition and with transition comes some pain. The rapid shift from record-low interest rates and liquidity-fueled markets to one of higher interest rates and central banks shrinking their balance sheets has impacted markets. This has been coupled with the ongoing effects of Covid on economies, notably China and the unexpected conflict in Ukraine with both events contributing to rising inflation which has been the topic du jour for all of 2022.
What can we expect from markets in 2023?
We should hit peak inflation in 2023. Central banks around the globe have been aggressively raising rates to curb inflation. In Australia the December CPI figure hit 7.8% with the cash rate target reaching 3.10% up from 0.10% in December 2022. Cyclical indicators have been broadly trending down and we are yet to see the full impact of rate rises on households. We believe that demand will show more material signs of slowing in the second and third quarter of 2023 which should see inflation stabilise.
Mild recession is a possibility. The inverted yield curve is suggesting that a recession is on the cards. Historically, recessions have occurred 12 to 18 months after the yield curve has inverted. While the likelihood of a recession is elevated, the relatively strong labor market is expected to reduce the risk of a deep prolonged recession. We do however expect segments of the economy to be hit harder than others, such as the construction industry which has already experienced a downturn following rises in interest rates. Conversely Australia’s exposure to materials and the expected reopening of China from strict Covid lockdowns is expected to benefit things such as iron ore exports.
Company earnings to slow second half of 2023. We are yet to see the full impact on demand on the back of interest rate rises. While the savings ratio has been declining as households increasingly dip into their savings, households are still spending with travel spending being the big winner. However, our expectation is that we will observe a slowdown in demand in the second half of the year as many household budgets get a jump in their mortgage repayments as their fixed rate loans roll-off and they move towards the higher variable rate. This should see a slow down in discretionary spending which should show up in company earnings later in the year.
Range trading market. Markets have started 2023 on a positive note. Some of acute issues that adversely impacted markets in 2022 have subsided. Energy prices, which rose sharply following the Russian invasion of Ukraine have fallen with European gas prices falling by over 27% in January alone. Furthermore, the consumer is still buoyant despite higher interest rates. As 2023 progresses and the impact of rising rates makes its way through the economy and company earnings come under increased pressure, we may see the market pull back. Net-net it is plausible that 2023 may be a relatively flat market characterised by spikes in volatility both to the upside and the downside.
From a portfolio perspective, if we experience a down market our Retirement suite of portfolios which have been first quartile performers during 2022 should hold up relatively well given their exposure to income generating companies and a range of absolute returns strategies. Likewise, our Multi-Asset portfolios which have a significant exposure to alternative assets should be able to buffer the downside due to the diversification benefits alternatives bring to portfolios. Our listed range of portfolios continue to hold exposure to quality companies and a diversified range of asset class exposures. Further downside will provide opportunities to gain exposure to quality growth companies that previously traded at significant premiums. Finally, our Sustainable range of portfolios which have experienced a challenging period in term of returns should see returns stabilize, provided that we do not experience another spell where energy prices rise sharply as the portfolios have limited exposure to energy given the focus on ESG factors and the awareness of the UN Sustainable Development Goals.
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