Those who cannot remember the past are condemned to repeat it
Before we look forward to recession and recovery in 2023, we need to review this year. Without knowing where markets and economies have got to, it is difficult to forecast the next move. That seems especially pertinent after this year when expectations have been continually side-swiped.
A review of asset returns up to the end of November, shows a dismal picture. The impact of war, energy crisis and inflation, as well as sharp hikes in interest rates, are clearly visible. Practically everything went down, including poor returns from inflation hedges like UK index-linked gilts, US TIPS and gold. Natural gas went literally off the scale, while oil was up more modestly. Latin America was the best performing equity region, led by Brazil, led by Petrobras, on the back of oil. In the same way, the UK outperformed amongst developed markets. This is the worse S&P performance in a Fed hiking cycle – interestingly the, now, second worst was 1973.
I also need to review my own forecasts from last year, rather than simply blaming unforeseen events. I, happily, was correct about the end of Covid’s economic impact in 2022 (except China missed that memo), and I highlighted the inflation risks, even before the energy crisis, but the Fed missed that memo. The result was that a later and sharper cycle of interest rate hikes triggered fears of recession and meant that I was wrong about equities outperforming bonds, as both did equally poorly, with a few exceptions highlighted above.
Asset performance 2022
Source: Bloomberg and Columbia Threadneedle, as at 30 Nov 2022. IG = Investment Grade, HY = High Yield, TIPS = Treasury Inflation-Protected Securities. Natural Gas Futures returns use Jan 2023 contracts.
Inflation is the key issue – but the solutions are different across the Atlantic
Inflation was a problem before the energy crisis. Central banks hesitated to slam on the monetary brakes in case the release of economies from Covid lockdowns was another false dawn. This is most clearly seen in the energy self-sufficient US economy, where the vast majority of current inflation is nothing to do with energy prices.
However, there’s more to it than a central bank mistake. Because, around the middle of the year, the US economy was clearly slowing down, heading for a soft-landing as interest rates ticked up. At which point the still-confident US consumer reached for the ‘covid piggy-bank’ and went on a last splurge that left the Fed and markets struggling to catch up.
That’s why, with unemployment still extremely low and wage growth high, we are cautious about predicting the end of this US economic and interest rate cycle until we can see clear signs of a recession. We think that the Fed shares these concerns, both because of a pragmatic acceptance of limits on accurate forecasting, but also a belief that cutting interest rates too early was key to entrenching inflation in the 1970s. However, outside inflation we see little signs of financial imbalances that might create lingering problems, so a US recession need not be deep or prolonged.
Inflation US, EZ and UK: US core higher, food and energy lower
Source: Columbia Threadneedle Investments and Bloomberg as at 28 November 2022
The energy crisis in Europe and the UK should be self-correcting
The coming recession in Europe and UK should cut energy consumption and extinguish other sources of inflation. Therefore, economic recovery can resume once energy prices fall in 2023. Governments are acting to cushion the consumer and economy from the worst of the squeeze, but also, ideally, encouraged reduced consumption and a switch to alternative sources, which means that energy prices can fall and the economy can recover sooner. We should continue to hope for a warm, wet and windy winter that cuts demand and boosts supply from hydro and wind power generation.
We can already see the impacts in the UK, with the all-important house prices falling. While they are still ahead on the year, they are already lagging inflation and we expect to see further falls.
This leaves less pressure on the European Central Bank and Bank of England to fight inflation by aggressively hiking interest rates. Though the discipline of an independent central bank will help give confidence to the process in the face of severe political pressures, as we saw in the short-lived Truss government. It’s amazing that markets seem to have forgiven the UK, let’s hope that we never do it again.
House prices already falling on some measures
Source: Columbia Threadneedle Investments and Bloomberg as at 2 December 2022
The market keeps trying to rally, but the Fed waits for data
Markets have rallied again from November, with the size of the latest shift down in US real yields only obscured by the scale of changes already seen in 2022. Market forecasts seem a lot more realistic than during the mid-year rally, at least in terms of interest rates. Valuations, for both equities and bonds are more attractive after this year’s falls. However, analysts are still forecasting earnings growth for equities in 2023, while we expect a 15% fall in a mild recession.
We prefer, like the Fed, to wait for the data. That suggests that the current rally is part of a continuing bear market, rather than marking a turning point. We would be cautious to pre-empt recovery before we have had a recession. That suggests that the end of the next quarter, after we are past the depths of winter and hopefully recession, would be a more appropriate time to look for turning points.
Analysts’ EPS estimates for 2023 look too high
Source: Columbia Threadneedle Investments, Datastream, as at 2 Dec 2022
Source: Columbia Threadneedle Investments, Datastream, as at 2 Dec 2022
For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is an advertising document. This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services.
Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. Risks are enhanced for emerging market issuers.
The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be appropriate for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either.
Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This is an advertising document. This document and its contents have not been reviewed by any regulatory authority.
In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.
In the USA: Investment products offered through Columbia Management Investment Distributors, Inc., member FINRA. Advisory services provided by Columbia Management Investment Advisers, LLC.
In the UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.
In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.
Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.
columbiathreadneedle.com Valid from 12.22 | Valid to 6.23 |