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Is there light at the end of the tunnel?

28 March 2023

Ninety One’s Iain Cunningham highlights areas of the market that might present significant opportunities in 2023, for investors who are willing to wait.

By Iain Cunningham,

Ninety One

Asset markets and investors experienced a tough 2022. Both global equities and bonds declined sharply, resulting in a passive 60/40 global equity/bond portfolio falling 18.1% in US dollars and having its worst year since 2008. The culprits where a combination of stretched starting valuations, major central banks moving to fight inflation and recessionary conditions in China.


So what will 2023 hold?

Starting with China: Heading into 2023, the Politburo, the principal policymaking committee of the Chinese Communist Party, has called for “significantly boosting market confidence”, “forceful monetary policy” and “reinforcing fiscal policy”.

This doubling down on policy, coupled with a rapid unlocking of the economy post the abandonment of zero-Covid polices and considerable pent-up household demand , should drive a robust recovery in economic growth and corporate earnings over the next year.

Simultaneously, equity valuations in China and Hong Kong remain depressed despite a recovery since China’s reopening and investors generally remain pessimistic on the region – we believe these dynamics create good selective investment opportunities.


Growth and earnings under pressure

Within developed markets, our central scenario is that the developed world will likely suffer the consequences of last year’s rapid and material tightening in monetary policy, as the lagged effects feed through into growth and earnings in 2023, leading to a recession. The casualties of this tightening cycle are already starting to emerge, such as SVB Financial and Credit Suisse.

The much-anticipated ‘Fed pivot’ seems unlikely in the near term until notable weakness in the economy has materialised – likely a precondition to sufficiently weaken the labour market and lower underlying inflation pressures.

Our conviction reflects the fact that the Federal Reserve remains focused on addressing inflation and tightness in the labour market, with “the level of wage growth remaining inconsistent with inflation returning to 2%”, according to Fed chair Jerome Powell.

Soft landings of the economy have also historically been associated with longer and shallower hiking cycles, while the pace and magnitude of this hiking cycle has historically been associated with a deeper recession.

In our view, these expectations are yet to be priced into developed market equities. Last year’s sell-off was a function of multiple derating as interest rates and bond yields rose, but there has yet to be much in the way of downward revisions in earnings. During a recession, earnings usually experience a 15-20%-plus decline.


Opportunities in high-grade government bonds

Another area where our central scenario for the developed world is yet to be priced is in developed market government bonds. In US Treasuries and other select developed market government bonds, real interest rates – a measure of value – are the highest they have been in 12 years.

In particular, we see the best opportunities in high-grade government bonds in countries where housing markets and households are already feeling the effects of current hiking cycles. These nations include South Korea, Australia, New Zealand and Sweden.

For example, South Korea has just entered its first phase of deleveraging since the Asian financial crisis, and the housing market in Sweden has already declined 17% from its peak. These nations face notable headwinds to growth and domestic inflation through 2023.


US dollar headwinds

Turning to currencies, we entered 2022 with a notable long position in the US dollar versus Asian and European currencies. This reflected expectations of macro policy divergence; we expected the Fed to fight inflation and tighten policy swiftly, while the People’s Bank of China would move towards easing.

Looking forward, we believe the US economy remains structurally more healthy than European countries and the above noted nations, and will likely tolerate higher rates for longer. This may favour US dollar positions relative to the likes of New Zealand and Australian dollar.

However, a reacceleration in Chinese growth and a tightening cycle from the Bank of Japan present notable headwinds to the US dollar through 2023, potentially beneficial for the Japanese yen.

All being said, 2023 will likely be a year where significant opportunity will be presented in developed market equities and credit – just not yet.

Iain Cunningham is co-head of multi-asset growth at Ninety One. The views expressed above should not be taken as investment advice.

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