Economic background
The major economic theme continues to be high inflation. Related issues of a cost-of-living crisis, an energy crisis, fears of recession and a significant stock market correction have complicated matters and sent bond yields jumping for much of this year.
Key questions remain about how deep these recessions are likely to be. Even as some prices, such as freight, gas and some other material costs have been falling recently, others are proving to be stickier. In addition, continuing labour supply shortages resulting from the pandemic period are keeping job markets tight and supporting strong wage growth demands.
Market background
Concerns that central banks would increase interest rates too far and too quickly has led jittery equity markets to decline for much of 2022.
Market hopes and expectations have focused on watching for the US Federal Reserve to turn away from raising interest rates. That has not yet happened, but several other central banks calmed markets somewhat by agreeing that the pace of interest rate increases might begin to slow down. However, uncertainties remain about how bad things could get for the overall global economy.
Economic outlook
Recessions look inevitable for Western economies. The economic statistics in the fourth quarter of 2022 will be challenging to adjust to in the new year, with the combination of softening economic activity, a likely decline in corporate profits in the fourth quarter of 2022 and the first quarter of 2023, and only a slowing improvement in the inflation outlook.
Market valuations
Even though we are not expecting that levels have yet to hit their low points for equity markets, we do think that the prospect of an upward bounce-back has improved for equities in 2023, given the declines experienced in 2022. With a fair amount of bad news already included in the prices, the potential for further declines is now more limited at the start of the new year than at the beginning of 2022. Furthermore, the likelihood that stocks will be higher by the end of this year has increased considerably.
Multi-asset strategies
For equities, the risks of corporate earnings disappointments are still tilted toward more room for more profit declines if central banks continue to increase interest rates for longer and by larger amounts than are currently expected. However, there are opportunities in a range of undervalued, income-generating, and conservative investments.
For government bonds, yields have risen substantially as central banks continue increasing interest rates. It also results in more attractive bond values and the prospect of selective opportunities across global fixed income investments. This is especially the case for amounts dedicated to high quality bonds and those with five years or less to maturity.
The UK and Europe have been fortunate to have had a mild autumn. This enabled fuel storage tanks to be nearly full as we enter the three key winter months. If the first months of 2023 are not extraordinarily cold, we are likely to make it through this winter without needing to resort to energy rationing.
The expectation is that economies will fall into a mild recession in 2023, reflecting tighter monetary conditions, a less supportive tax policy, and the loss of purchasing power for households. Even though inflation is likely to remain above central banks’ targets, inflation should start to moderate as the economies slow, logistics pressures ease and the labour market weakens. Despite this type of economic setting, the new year is likely to provide a more positive market outlook for both equity and bond investors than was the case in 2022.
How can we help?
Our financial advisers are here to help you navigate the current market conditions, and support you to make smart investment decisions. To find out more visit our wealth management pages, or contact Richard directly, at richard.basford@nfp.co.uk