2023: a time for REFLECTION?

It’s been yet another quite incredible year for global financial markets. Our head of markets takes his seasonal look at what’s gone on and what could happen in 2023.

Last year we asked whether investors should be CIRCUMSPECT in 2022, noting the factors

Consumer

Interest rates/inflation

Rotation

China

US/UK economic recovery

M&A

Strong comparatives

Policy sensitive

Expiration of pent-up demand

Choice: risk assets the only game in town?

Transition to online shopping – how much is here to stay?

And, indeed this turned out to be the case as most major markets suffered from fears of inflation, aggressive monetary tightening and the possibility of recession.

At the time of writing, the Dow Jones Industrial Average in the US has fallen by 7% in the year to date, the S&P500 by 16% and the Nasdaq by 28%.

In the UK meanwhile, the FTSE100 has added just 2%, while the more domestically focused FTSE250 is down 18% during the year.

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This year, we ask, in our annual acronym – will 2023 be a time for REFLECTION?

Recession

Earnings

Federal Reserve/central banks

Loan loss provisions

ESG – has it been on pause?

Consumer

Total returns, including dividends and bonds

Inflation/interest rates

Online – post pandemic levelling

Nasdaq, value vs growth?

These factors are the most likely to influence investors and are as follows:

Arguably the most prevalent concern this year has been whether the Federal Reserve’s aggressive rate hiking policy will tip the world’s largest economy into recession. This will remain the nub of the matter, particularly in the earlier parts of the year and will set the sentiment scene depending on the outcome. At present, it is also unclear whether earnings valuations are up to date with reality, especially in the event of an economic downturn. As such, quarterly updates and outlook comments from the companies on the ground will assume extra significance.

So, at which point will the Federal Reserve and other central banks be satisfied that they have tamed inflation? They are already anticipating rates remaining higher for longer and, as discussed below, inflation could be rather more sticky than central banks would like to see.

Will the domestic banks continue to make loan loss provisions if economic conditions deteriorate? Previous provisions taken during the pandemic were released after lockdowns eased, but economic pressure is already seeing these return. This leaves the possibility of lower profits and even lower dividends if the need to protect their capital cushions prevails.

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Has ESG - Environmental, social, and governance- investing taken a back seat in 2022? At the time of writing, four of the top five best performing sectors in the UK market this year have been the oils, tobaccos, miners and defence – the movement toward “sin stocks” may have been reflected by investors’ desire to chase safer returns. However, it is noticeable that companies are devoting more time to their environmental credentials when reporting, a theme which will now become entrenched.

Consumer sentiment has recently dropped, but not necessarily activity. With the consumer being a vital cog in the US growth engine, this will have a strong bearing on performance. Of some concern could also be that there is increasing evidence that spending is being loaded on to credit cards, which could provide an additional headache should the world’s largest economy veer into recession.

Total returns, namely the combination of not only capital growth, but also income are a vital tool in the investor’s armoury. In addition, reinvested income benefits from the power of compound interest. Higher yielding bonds have also become something of an alternative given rising interest rates, such that investors may have more choice in identifying secure income streams.

Inflation and interest rates are intertwined. Will 2023 see either or both of them fall? The consensus is that interest rates could be near to peaking, and at levels which give central banks some flexibility if there is a need to reduce rates next year to promote growth in the face of possible recession. Inflation looks likely to remain a central area of concern. Year on year comparisons will likely drop, but inflation could remain high. Deglobalisation and the need for countries to be more self-sufficient, which came to the fore during the pandemic, could mean that the low inflationary environment of recent years could be much harder to replicate.

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Has online trading now reverted to the norm? There is mounting evidence from retailers, for example, that the previous mix of online and physical shopping is now slowly returning to pre-pandemic levels. Even so, pressure will continue to come in different forms, not least of which is a deteriorating economic environment and the weakening of the consumer’s propensity to spend.

Will the Nasdaq recover its previous poise? It had long been a target for growth investors, but had the market become too overvalued? This year’s steep losses were exacerbated by the rotation from growth to value stocks, but much quality remains. Indeed, it may also be fair to say that investors ignore the tech giants at their peril, since there is plenty of scope for further growth. Many of them have dominant, and in some cases, unassailable positions in their market and are prime examples of what Warren Buffett would describe as having a “moat” around the business, namely a competitive advantage which allows the company to maintain both pricing power and higher profit margins