The lack of bad news in 2023 should be good news

In 2022, the market priced in the bad news that continued to accumulate. We have witnessed the deterioration of Sino-US relations and related trade tensions; The Covid pandemic and resulting supply disruptions; Russia’s intervention in Ukraine and rising tensions over energy resources; and a large wave of resignations and a decline in the activity rate. In addition, we experienced a period of strong volatility as continued headline inflation, rising interest rates, recessionary expectations and changing government policy in the UK.

These macroeconomic conditions are expected to continue for most of 2023, but they are not necessarily expected to lead to a deep and prolonged recession, especially in the US. As long as things don’t get too bad, investors can be a little more optimistic and market conditions can improve. We estimate that the recession in Europe will be stronger than in the US, but the unpredictability of the conflict between Ukraine and Russia prevents us from integrating this assumption into the central scenario. But in any case, the lack of bad news can turn into good news for investors.

Inflation and interest rates: 2023 won’t look like 2022

In the United States, core inflation should decline, barring significant increases in energy prices. Core inflation is expected to continue, but a flat or downward trend would mean the US Federal Reserve could stop raising interest rates as early as 2023. We did not expect monetary easing with interest rate cuts, but with some stabilization, 2023 should not look like 2022.

When it comes to interest rate hikes, the European Central Bank (ECB) has more to do than the Fed. As the ECB only starts its tightening cycle in July 2022, it is unlikely to raise rates as much as the Fed, but may have to do so for a longer period. But the inflation picture in Europe is a little unclear due to the war and the region’s dependence on imports, especially energy. While the United States was more autonomous in this respect, Europe had to build energy reserves [1]but a particularly severe winter can lead to malnutrition and further contribute to the economic slowdown.

Meanwhile, UK interest rates remain somewhat unpredictable following government and policy changes.

Overall, even if global interest rates are not expected to decline in 2023, the end of market conditions at their terminal level could be a positive catalyst (figure 1).

Figure 1: Most developed country central banks (in yellow) are expected to reach the terminal stage by 2023

Source: Bloomberg, November 2022

A recession scenario with twists and turns

Therefore, recession in Europe seems inevitable. In the US, we will have to watch the Fed to see how much it judges that economic hardship is a necessary evil to fight inflation. Given the risks, while I don’t think the recession will be anything like 2020 or 2008, a focus on quality (whether at the asset class or regional level) will be key to the extent that some companies can weather expectations. recession is better than others who are less prepared for it.

In the bond market, credit quality will be a more critical success factor than in 2022, when duration is key. Many companies have built strong balance sheets in an era of low interest rates, but the generalized decline in valuations has created pockets of opportunity in the markets.

The situation is similar in stock markets, the condition of success is the quality of earnings and balance sheets. Although the pandemic seems to be over in Western countries, activity has not yet fully normalized. However, consumers prefer services and recovery sectors are different from 2020/2021. During recessions, we tend to avoid economically sensitive sectors and caution is advised, but this “return to normalcy” offers opportunities even in the face of an impending recession.

Whether in stocks or bonds, identifying winners with strong balance sheets that can ride out a downturn will require sharp analytical skills, a quality we at Columbia Threadneedle pride ourselves on possessing.

We also need to consider that the environment is different from previous decades: the low-inflation periods of the 1970s and 1980s, so we need to be careful when extrapolating which companies and sectors will do well in the coming years. . When money was cheap, weak businesses could survive longer than they could in an environment where money had a more “normal” value. Therefore, they will have to face new problems.

The focus on quality also applies to relative regional capabilities. Europe is cheaper than the US but faces stronger headwinds. Emerging markets dominated by China are also relatively cheap, but have problematic geopolitical relations and trade restrictions. The United States offers relatively reasonable valuations and is a key market. Again, research and analysis will play an important role in identifying the right opportunities.

Power switch tested

When it comes to renewable energies, Russia’s intervention in Ukraine has created a dilemma in Europe. On the one hand, the increase in the price of fossil fuels will accelerate the energy transition with self-sufficiency established as an absolute priority. But on the other hand, the energy crisis led to an increase in the use of coal and nuclear power plants, which had to be closed. [2]. Therefore, Europe is necessarily taking a step back in terms of its policy to reduce carbon emissions, but is encouraging investment in renewable projects. [3]. This leads to the sensitivity that we need to pay attention to in terms of ESG (environmental, social and governance criteria). The crisis has highlighted that the reduction in fossil fuel supply has increased the price. From an environmental point of view, this can be beneficial, as the higher price reduces energy consumption. But socially, this is problematic, as the less affluent spend more of their income on energy costs. Finally, the environmental gain is offset by the negative social impact.

However, rather than setting back ESG opportunities due to continued fossil fuel production, this will improve opportunities for renewables as increased investment is expected to drive future growth.

The result

It’s hard to remember a year with as much bad news as 2022. Designing and developing a central scenario is not easy, as the risk of an expansion of the war in Ukraine and its consequences in Europe is difficult to calculate. Regime change in Russia. At the same time, rising tensions between China and the US have raised risks for emerging markets, prompting us to be extra cautious. We believe inflation and interest rates will remain elevated in 2023, but their stabilization should provide some support. Markets did not expect a Russian invasion at the beginning of 2022, and a similar “blind spot” is possible in 2023.

We believe we are well positioned to deal with this uncertainty. At Columbia Threadneedle, we are connected globally with over 650 investment professionals located in Europe, North America and Asia. [4] who share a global perspective across all major asset classes and major markets. We strive to continuously improve our analysis and research. Our investment approach is based on a dynamic and interactive culture and collegial, performance-oriented and risk-aware processes. This approach has allowed us to achieve good results in the long term, and we are sure it will be the same in 2023.

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