Neil Birrell
Premier Miton’s Chief Investment Officer
This update should not be taken as advice. If you are unsure about any of the content please contact your financial adviser. Please remember that the value of financial market investments will fluctuate and investors may not get back the original amount invested. To assist, where appropriate, a glossary explaining some of the terms used has been provided at the end of this update
Next year, this year
Each December it is inevitable that those of us who spend time commenting on economics and financial markets will be drawn into reviewing the year that is about to end. I am no different, but I will try and keep it concise; it will be much more interesting and useful to look at what might happen rather than what already has!
2022 was quite a year for the global economy
But there again so were 2020 and 2021; the COVID years!
It is worth taking a moment to look back at 2022, if for no other reason than to set the scene for 2023. Firstly, it would all too easy to forget that as we rolled into the year the likelihood of Russia taking aggressive military action against Ukraine was increasing.
Inflation was spiking almost everywhere and central banks had to admit that it would not be a passing problem but one that would potentially worsen and linger. They had to start raising interest rates in a more aggressive manner to stand any chance of subduing the perils of inflation. But that, heightened another risk; recession, and that was considered to be more of a danger than inflation.
Then the Russians invaded Ukraine bringing about awful social and humanitarian strife. It also turbo charged the economic issues at hand; supply chain shortages worsened, energy and food prices jumped and inflation surged. It was around this time that central banks realised inflation was close to being embedded and changed their view to be that inflation was the greater risk, not recession. In essence a long period of high inflation would do more medium- and long-term damage than recession, and they were right.
That has been the case for the rest of the year. There is only really one blunt tool to tackle inflation and that is to put interest rates up, which is what has happened, on a record-breaking scale.
And quite a year for financial markets as well
It should be expected that bond and equity markets would suffer in such challenging conditions and they did. The problem was they were coming off a period of strongly rising in prices and did not look cheap. Therefore, the fall was painful.
The most painful part was the impact of sharp declines in bond markets, which are usually considered to be lower risk that equities; that has not been the case in 2022 for the most part. It has meant that investors with a lower risk approach may well have lost more money than those with a higher risk profile.
When the UK became the centre of attention
It’s easy to focus too much on the domestic scene particularly as the UK is relatively small if measured on a global scale by population or stock market. However, in September the whole world was looking at our politics, economy and bond market.
The unstable political backdrop was thrown into chaos and the government bond market was moving in way never seen before driven by what was described as a “mini” budget. Its ramifications were anything but mini! This was another example of where political and financial market events can have real world impacts on people’s lives in a negative way. Thankfully, action was taken quickly, and the situation stabilised. Although we are not out of those woods yet.
2023 will, no doubt, be quite a year for economies as well
The word that is getting used more than most to describe the outlook for economies and markets in 2023 is “uncertain”, and I think that is as good as any. Obviously, we never know what is going to happen, but we can have a view on what we think might happen; so, let’s have a go at that.
At the top of the agenda must be the economic outlook. There are times when major regional economies are more synchronised than others and we may be entering a period when they are less in synch. This causes greater stress in the global economy, as demand and supply patterns shift and currency moves can be of significant impact.
The US is the world’s largest and most important economy, it is a key driver of what happens elsewhere and it appears, for now to be in pretty good shape. As I write this, there is hope that inflation may have peaked, that we can look forward to a slowing pace of interest rate increases, with the peak currently expected to be in the second quarter of 2023, and that the economy may only go into a mild recession; that would be considered as a great outcome.
Next up; China. COVID induced lockdowns, a highly stressed property sector and tightening regulations may cause the economy to slow at concerning pace, which is not good news. Indeed, the current social unrest can only exacerbate the problems. The Eurozone, for now, is surprising on the upside, but that is unlikely to last, whilst the UK is already in recessionary conditions, with little to look forward to next year. Meanwhile Japan, remains hamstrung by historical structural issues. This means that government and central bank policy is likely to vary from one region to another as the twin threats of high inflation and slowing economic growth are addressed.
Beyond 2023
Let’s be clear, 2023 is likely to see the world economy in or near recession, with many, if not most countries in recession to one degree or another. One thing that concerns me is, where is the growth coming from after that? Looking at economists’ forecasts does not provide much comfort; very modest economic growth in 2024, 2025 and 2026 is the consensus.
But 2023 can be a better year for financial markets
The backdrop is not great, caution is the watchword, uncertainty abounds, but there may well be money to be made next year. The one question I am asked the most these days is; when will it be time to buy? The answer to that is; I don’t know. However, I do have an opinion; but I’ll stick with the main asset classes.
Bonds have fallen so far, so fast, that the fear of “catching a falling knife” has probably stopped many investors taking advantage of what, frankly, looks like a good entry point. But – yes, there’s always a but, and quite a few of them – interest rates are still going up and there is no evidence that inflation has peaked everywhere, let alone been beaten. The global bond market is enormous and is not homogeneous; parts of it look attractive and parts of it look unappealing to me. Many high-quality bonds issued by companies have fallen to levels that offer much better returns than they have for many years. In essence, the fall in the price of bonds means that better returns are available for less risk than has been the case for a long time. As ever, though, it’s important to be selective in what you buy.
Equites have reached valuation levels that, on the face of it, look attractive. However, economic activity is slowing, borrowing costs are rising and profit estimates are not, in our view, reflecting those factors. This is one of the major reasons I think there is some downside to equities, overall, from here. Although, having said that, I think that will take place in the shorter term and as we move through the economic cycle, profits expectations will improve, which is usually a positive factor for share prices. So, 2023, overall could, probably should, be a better, hopefully, positive year for share prices. Trying to time entry and exit points in equity markets is very, very difficult; being in the game for the long term is the most important thing.
My thoughts above are predicated on geo-political matters in Ukraine and China not escalating and caveated by the fact that I may well be wrong!
Pulling it all together
It’s been a tough 3 years globally for society and the economy. In economic terms 2023 will be tough as well, but as we go through the year, as things stand, the situation should improve and the outlook may get better as well. If we are realistic in our expectations, I can see that financial markets will be rewarding once more. However, in my view, it will be vital to be selective in what you invest in, as risks are still high and uncertainty remains.
The last word
Each month, when I write these notes, I start with the intention of keeping them brief. I nearly always fail, there has been so much to discuss. My wish for the new year is there is less to discuss in 2023.
