For investors, 2023 is likely to play out in two distinct halves. In H1, we expect recessions in the US and Europe and a gradual recovery in China. This is likely to be followed by a revival in global sentiment in the later part of the year as western central banks start to ease policy and China’s reopening and policy measures feed through to the wider domestic economy. This world view, which we outlined in our 2023 Outlook, “Playing it SAFE”, calls for a defensive stance in investment allocations at the start of the year: earning income through an overweight in high-quality bonds and underweight in equities, with a regional preference for Asia ex-Japan, while looking for tactical opportunities in equity sectors and currencies. We are likely to get better entry opportunities for equities outside Asia later this year once western central banks cut rates as recession sets in.
The latest US and Euro area PMI data and China’s recent policy measures support our central view. US manufacturing sector business confidence (ISM PMI) for December indicated a second straight month of contraction in underlying activity, with the forward-looking new orders PMI staying in contraction territory for the fourth month (the US services sector remains healthy though, with the consensus expecting ISM Services PMI at 55, as consumer demand shifts from goods to services). European PMIs also remained contractionary, although they improved from October’s lows. Meanwhile, China’s PMIs fell deeper into contraction due to a surge in COVID-19 infections.
Against this backdrop, Developed Market central banks, especially the Fed, are likely to decide the fate of asset returns this year once again – the key is assessing how soon they are likely to pause tightening. We expect the Fed and ECB to keep tightening in the coming months, likely taking their benchmark rates to a peak of 5.25% and 2.5% (deposit rate), respectively, to sustainably subdue wage and inflation pressures. The Fed’s December minutes showed policymakers are concerned about easing financial conditions too soon. Yet, they are conscious that “the lagged cumulative effect of policy tightening could end up being more restrictive than necessary”.
The minutes suggest, despite the contraction in manufacturing, policymakers are unlikely to pause tightening in the next few months unless they see signs of a sharp deterioration in overall economic activity and the job market, and a sustained decline in inflation. Data this week showed US job openings remained high and jobless claims low (December’s non-farm payrolls report will likely confirm the job market strength). Meanwhile, consensus estimates suggest inflation remains high at 9.5% in the Euro area and 6.6% in the US (due 12 Jan).
Although recessions in the US and Europe are widely anticipated as the central banks keep tightening, we believe they are not priced into equities. In the US, except for the healthcare sector, downward revisions to corporate earnings still fall short of the average of the past three recessions. Asia ex-Japan offers a ray of hope against this backdrop. Mainland China’s reopening has been faster than expected, leading to the normalisation of mobility across major cities. China has also announced measures to boost sentiment over the past week, providing more liquidity to property developers, exploring coal imports from Australia and allowing Ant Group to raise capital. It will reopen the Hong Kong-Mainland China border from 8 Jan.
Investment implications: Against this backdrop, we maintain a. SAFE stance in foundation allocation by: i) Securing our yield via income strategies, ii) Allocating to Asian assets that offer long-term value, iii) Fortifying against surprises via defensive assets, and iv) Expanding through alternative strategies.
b. Tactical opportunities in: China’s consumer-focussed equity sectors (consumer discretionary, communication services)
c. Opportunistically add to JPY and EUR on pullbacks as the USD structurally breaks lower, aided by the BoJ’s recent surprising hawkish shift in policy.
By Rajat Bhattacharya Standard Chartered
