After a difficult year for markets, pundits are setting out their forecasts for the economy and the various asset classes in 2023
by Brian Gorman
Investment pundits are generally upbeat on the prospects for fixed income in 2023, but hold out little hope of a major recovery for equities.
In major economies worldwide, double-digit rates of inflation, and the higher interest rates brought in to combat them, have severely affected investors’ confidence. Some US data was especially bleak. In 2022, the S&P 500 index of the biggest equities is on track to notch up its worst year since 2008, falling some 20%.
Franklin Templeton strategists say 2023 “holds out the promise of renewed potential for benefiting from diversification”, while noting that 2022 was “wretched” and was one of only five calendar years since 1948 when both US stocks and US bonds fell.
Morgan Stanley said the S&P 500 would “tread water” in 2023 and finish the year at 3,900, while 10-year Treasury yields will end 2023 at 3.5%, compared with a 14-year high of 4.22% in October 2022.
Battle against inflation
The outlook for inflation in 2023 is a key factor in determining the prospects for several asset classes in 2023.
Asset manager Vanguard Group says that a number of factors will help bring down inflation in 2023 including rapid monetary tightening but that this could also result in a more challenging macroeconomic environment.
Vanguard notes that supply-demand imbalances are set to linger in many sectors as global supply chains have yet to fully recover from the COVID-19 pandemic and “as demand is supported by strong household and business balance sheets buoyed by pandemic-era stimulus”.
The fund manager said that the conditions were similar to those “that have signalled global recessions in the past”.
It says the Bank of England base rate will rise to 4.5% by the end of 2023, compared with 3.5% now, and that the US benchmark Fed funds rate will also rise to 4.5%, slightly higher than the present level. UK GDP will contract by 1-1.5%, while US GDP will grow a meagre 0.25%, said Vanguard, and the Euro area will neither grow nor contract.
Outlook for bonds
However, there may be opportunities for some investors. Vanguard’s bond-return outlooks for UK-based investors are more than three percentage points higher than they were a year ago, as cash flows can now be reinvested at higher interest rates. It projects UK bond returns of 4.7%-5.7% per year on average over the next decade.
Franklin Templeton has also identified areas of the bond market that investors should consider. It says Investment-Grade (IG) corporates look attractive for those seeking relatively safe income. Franklin adds that High Yield credit is attractive for those with a multi-year time horizon. “Current yields and active selection provide a cushion for potentially near-term higher defaults in the sector,” says Franklin.
Infrastructure looking solid
Franklin says “Equities are less likely to perform as well” but that the impact of inflation on listed infrastructure in 2023 should be “muted”. It said infrastructure earnings look better protected in general than global equity earnings.
Investment bank Macquarie echoes this view. It has a “medium to-low” conviction rating for equity markets in 2023, but a “medium to high” stance on both debt markets and real assets.
“Infrastructure is a standout”, says Macquarie. “It offers inflation protection, defensiveness, high yield, and exposure to structural growth drivers, all of which should be attractive to investors in 2023.”
It says the rise in interest rates globally means the near-term outlook for real estate is more challenging.
Strategists at Italian insurer Generali, noting the impact of the war in Ukraine, said the headwinds to the global economy were likely to mount further in 2023. Generali favours euro-denominated IG credit, which it said was cheaper than other credit segments, especially global High Yield and US credit.
However, it warns that, more generally in the euro area, it still sees risks to bond yields “moderately geared to the upside short term on a deteriorating supply/demand balance”. Generali says fiscal plans for 2023 point to significant bonds issuance just as the ECB is preparing Quantitative Tightening (QT). It is more positive on US Treasurys, saying that yields have passed their peak.
The pessimism on equities was not unanimous. Schroders identified one area of the market as offering interesting prospects: UK smaller and medium-sized companies, or “smids”.
Valuations are “very beaten up” said head of UK equities Sue Noffke, adding that the market was not distinguishing between good and less good companies.
She pointed to the possibility of some of the smids being vulnerable to bids, adding that US buyers paying in dollars continue to have a currency advantage.