2023: where to invest in a world sick with polycrisis

2023-01-01T05:10:55.539Z

Experts advise investors to be cautious in a context of maximum economic and geopolitical uncertainty where financial markets will continue to dance to the tune set by central banks

For the world of money, this 2022 that is ending has been the worst year in history for bonds and has resulted in abundant and generous falls in the main stock markets in the world.

With the Russian invasion of Ukraine as a dark and sad backdrop since last February, the bad news has followed one another: very high inflation data, resounding increases in interest rates by central banks in response, supply problems and prices of energy and raw materials, and economies in the process of slowing down their growth with the question of whether in 2023 they will enter a recession and whether it will be mild or severe.

Perhaps within the different analyzes that investment banks, research departments and fund managers publish these days, that of the American firm Fidelity can well summarize what is expected for 2023: "Weathering the polycrisis".

Looking for common elements about the future of the markets, there is a consensus among the experts that next year there will be sudden movements in the Stock Markets (high volatility) that invite us to be very cautious, especially in the first part of the year, which will continue to be marked by the increases in the price of money by the European Central Bank (ECB) and the US Federal Reserve (Fed), always following the steps of inflation.

And, furthermore, a scenario forgotten in at least a decade, from zero and negative rates to a new world where "money has a cost again",

as indicated by Allianz Global Investors.

This cost must be paid by States, companies and individuals.

And, furthermore, the central banks will reduce their balance sheets, removing even more liquidity from the system.

As for currencies, the expert consensus points to a weaker dollar against the euro, thereby making energy cheaper.

If it occurs, the fall in the greenback should also have a soothing effect on emerging markets.

In a market that is expected to be difficult, at least in the first half of the year, the experts consulted for this report advise investors to be very cautious, with strategies that prioritize the shares of companies with stable businesses and short-term bonds until the unknown is cleared up. rates and the economic slowdown that will reduce the profits of companies.

Forecasts for this 2023 that, as always, must be taken as an indication of the issues that may affect the markets, since, as the playwright Plautus said more than 2,000 years ago, "the goddess Fortune single-handedly disrupts the forecasts of a hundred wise men ”.

Here's the investment advice offered by analysts for the major asset classes.

equities

The vision of the Stock Market is somewhat contradictory among the experts.

Europe will suffer more than the United States from the economic slowdown due to its energy problems, but, at the same time, the Old Continent's indices are cheaper than those of the United States, which, in theory, should make them more attractive.

In addition, after many years without competition, bonds now offer returns and, therefore, money will be very aware of whether or not it pays to take the risk of shares.

Analysts at global investment giant BlackRock underweight developed-market stocks and favor higher-quality fixed income.

"In investment grade bonds we see that the economic cyclical damage is already discounted."

They consider the 4% profit growth forecast for Europe next year to be too optimistic.

“We expect to be more stock positive again sometime in 2023, but we are not there yet.

And when we get there, we don't see the sustained bull markets of the past.

“We prefer energy and financials, and we like healthcare for its attractive valuations and likely cash flow resilience during periods of crisis,” they conclude.

Nor do they see clarity in the US stock market from the investment bank Goldman Sachs: "In 2023 we expect zero growth in corporate earnings to result in zero appreciation for the S&P 500 index."

And they draw two clear halves in the year, with a first semester in which the S&P 500 falls to 3,600 points -now trading at 3,783 points- and ends the year at 4,000 points when the Fed stops raising rates in the middle of the year and investors focus on 2024 earnings. They view rates as unlikely to start falling next year "unless there is a severe downturn in the economic and earnings outlook."

Thus, business results will be key to the evolution of the Stock Markets next year.

Víctor Matarranz, global head of Santander Wealth Management & Insurance, believes that "the adjustment of profit expectations has begun, but it is still incomplete, and it is likely that these will continue to be revised downwards in line with the prospects for an economic slowdown for 2023 ″.

In addition, he considers that the greatest opportunities are in biotechnology, energy transition, cybersecurity, foodtech, robotics and sustainability, and highlights the renewable energy sector due to the global priority of guaranteeing energy supply in a sustainable manner.

However, for the analysts of the British Barclays, the deterioration of corporate profits may already be discounting.

“We forecast a 12% drop in the profits of listed companies.

However, we believe that a drop of 10-15% in EPS [earnings per share] is already discounted, since the evolution of the Stock Markets tends to be ahead of the economic cycle”.

And they add: “The prospects are not rosy and the possibility of a hard landing for the economy is not discounting.

Despite this, history shows that equities can rebound even when growth is weak”, they conclude.

Also from Renta 4 they appeal to caution for the shares and ask to enter defensive companies in 2023, since they consider that reductions in the results are still pending.

"The definitive floor of the Stock Markets goes through the control of inflation, a turn to neutral in monetary policies and the reduction of pressure on the cycle and profits".

In the short term, they recommend US equities, as they expect less macro deterioration, and in the medium term, they bet on European shares because they offer more attractive valuations.

Fidelity also envisions a lot of volatility and uncertainty for the stock markets in 2023. The fund manager's experts believe that Europe is the most exposed to a recession: "Everything depends on whether companies and consumers can spend the winter without power cuts and how the conflict in Ukraine develops from now on.

The extreme risks for the Stock Markets remain with rate hikes at a time when households are already experiencing high inflation”.

The US offers, according to Fidelity, a different picture and the actual data has yet to turn lower.

And they add that the risk is that the S&P 500 “falls more dramatically” if growth slows sharply.

"Meanwhile,

Analysts at UK fund manager Schroders are more positive in a recent report as energy prices ease and supply chain disruption from the pandemic slowly comes to an end, though they worry about the deceleration of the economies and the withdrawal of liquidity by the central banks.

They expect a reduction in profits in energy companies, after their maximum profits this year, and a good performance by banks, capital goods and semiconductor companies, as long as the recession does not drag on.

This same week, Bankinter's analysis team also presented its expectations for the start of the new year, in which they do not show geographical preferences in their recommendations.

“We maintain a purely sectoral focus.

In this sense, we recommend infrastructures, banks and insurers, luxury consumption, technology selectively and luxury cars.

In short, the stock markets will advance slowly, but the blocking phase seems to be getting over ”, they point out from the bank.

“Tactically, we are quite positive on European equities,” says Marcus Poppe, global equity portfolio manager for DWS.

“The valuation discount to US stocks, at 31%, is more than double the 20-year average (14%).

The outlook for value stocks, which have a higher weighting in European indices than in US indices, remains positive,” he adds.

From DWS, the health sector stands out, as well as companies in the industrial sector whose business models are based on the advancement of energy efficiency.

Fixed rent

The bond market has experienced the worst year in history.

The yield on the 10-year US bond began in January at 1.47% and is now trading at 3.65%, and in the German bond the range has gone from -0.29% to the current 2.26% .

Bond prices —which evolve inversely to profitability— have had to adjust in the market to the rise in rates, with strong losses in value.

And, furthermore, although analysts believed that long-term bonds had already known their maximum profitability, the ECB and Fed rate hikes in mid-December have caused further falls in their prices.

Thus, experts consider that fixed income is not yet stabilized, something also key for the progress of the Stock Markets with which it competes.

Another general concern in the world of corporate bonds is that the recession increases the risk of default, something that in theory should only affect the so-called high yield debt (high yield), compared to the investment grade (investment grade) that they issue strongest companies, according to credit rating firms.

In general, the bond investor will run less risk by buying short or medium term debt, while long terms fluctuate more.

In the case of the US, the inverted interest rate curve —a traditional indicator of recession— also encourages short investment: one-year bills yield 4.65%, while the 10-year bond is one point less profitable.

DWS analyst Thomas Höfer highlights the good time to get into corporate fixed income now: “Euro corporate bonds with good credit ratings offer returns of just under 4%, a level we last saw more than 10 years ago” .

And he highlights other opportunities such as senior bank bonds and hybrid corporate bonds, with yields of 6-7%, and also the riskier euro high yield bonds, which currently yield 7.3%.

Bankinter analysts are betting on average terms of two or three years and five-year corporate bonds of high credit quality.

Goldman Sachs's bets for 2023 also move in the short term: “The main risk of assuming more duration comes from the prospects of a greater loss of capital if yields continue to move higher.

The main risk of taking an exposure to corporate bonds is the recession”.

And they indicate that “the short duration in high quality fixed income provides more protection against both risks and also offers its best performance in many years”.

Nor do they move away from this discourse from the BlackRock manager.

“Given the prospect of a recession, the historical investment manual would suggest stockpiling long-term government bonds, but in our view, that traditional manual will not apply this time around, as the ECB is likely to continue to tighten its policy. even when the recession has already started.”

Foreign exchange

Since last September, when the euro was trading at $0.97, the European currency has not stopped rising and is now trading at $1.06.

Analysts agree that the dollar is overvalued against the euro, but, without a doubt, as long as central banks are raising rates, it does not seem that the situation is going to change.

For Credit Suisse analysts, the greenback will continue to be overvalued in 2023. "An inflection in the strength of the dollar continues to depend largely on a turn in US monetary policy and an improvement in global growth prospects," indicate.

For Renta 4, the strength of the dollar will continue in the short term given the greater relative risk of recession in Europe compared to the US due to energy dependence and the refuge effect of the greenback in the face of global uncertainty.

Along the same lines, Claudio Wewel, currency strategist at J. Safra Sarasin Sustainable AM, indicates that the dollar should not appreciate much more and that it will probably peak in the first half of 2023.

In Goldman Sachs they also find reasons for a strong dollar in the short term: "The US economy and labor markets are showing resistance and, in addition, the US economy is likely to avoid recession," they indicate.

As for the emerging markets, analysts still do not see a clear opportunity in China despite the sharp drop in its stock markets.

The effects of its zero covid policy and the imbalances in its economy advise prudence.

Credit Suisse believes that Chinese equity markets will underperform in the first half of 2023, resuming the strong downward trend started at the beginning of 2021. These negative outlooks are reinforced by a series of negative sector developments and the weakening of the yuan against the dollar.

From Schroders they also argue that the tensions between the US and China, a rival defined by the Government of Joe Biden as a "strategic competitor", will not help the Asian giant.

If the dollar finally weakened, it would be a boost for emerging markets and especially for Latin Americans.

The manager Robeco highlights that "the year could be especially good for emerging equity markets, excluding China."

And he adds that not only do these countries tend to outperform their developed counterparts in a bear dollar market, but the EM earnings cycle phase is more mature, “as their central banks have gotten ahead of the banks.” Developed market centrals in the fight against inflation.

The hour of small values?

The fall in the stock markets in 2022 has affected practically all markets and values with a special impact on growth companies, with technology companies in the lead, whose US Nasdaq 100 index was left until Thursday (closing day of this edition). 34.7% of its value.

In the case of the Spanish market, the Ibex accumulates an annual decrease of 4.76%, a fall that has been surpassed by the index of median values (6.87%) and, above all, by the indicator that groups the small values (-12.4%).

Outside of Spain, the shares of more modest companies have also had a significant setback in their prices.

The MSCI World Small Cap —it accounts for 4,056 companies from 23 developed markets— loses 21.26%.

Schroders' Bob Kaynor notes some parallels between the crises of the 1970s and the tech bubble of 2000, when the market recovery was led by small stocks.

“Smaller companies haven't been that cheap relative to bigger ones since the tech bubble of 1999-2001. In the seven years after the market peaked in March 2000, small firms capitalization rose more than 70%, while the large ones did less than 10%.

The last time relative valuations were this cheap and sentiment at such low levels ushered in an unrivaled period of returns for small- and mid-cap equities,” he explains.

Despite the fact that, in theory, small and medium-sized companies are less resistant to an economic slowdown as expected, he bases his bet on the fact that "this constant superior profitability in different economic environments occurred from a similar starting point: a great growth of earnings combined with low valuations compared to the large-cap segment,” concludes Kaynor.

A view that coincides with Fidelity, which in its outlook report for 2023 highlights that small- and mid-cap stocks are cheap compared to large-caps, "which should offer some opportunities for investors."

The British bank Barclays also sees an opportunity for this segment of the market due to the good valuations they offer.

“Small-caps look very cheap and, in our opinion, they are probably already pricing in a lot of bad news,” they argue.

The consequences of the end of an era

Central banks have gone from heroes to villains in just a few months, especially for those who must bear debt;

from the States to those with mortgages or those companies that are hardly viable without zero financing cost.

This healing effect of the ECB began in 2011, when the euro intervention rates stood at 1% in December 2011, the level from which the race to zero rates began that lasted until July of this year with the first rise. of the price of money (currently at 2.5%).

The same would be attributable to the Federal Reserve, which in 2008 placed its price of money at 0% to later make increases to 2.25% (December 2018) and culminate again in 2020 with free money.

In March of this year the escalation began that has already put the level at 4.5%.

It has been, therefore, many years of guardianship of the central banks to the markets, assuring years of rises in the Stock Market and also great revaluations in the bond market.

But now both the Fed and the ECB have opened a new period that analysts are trying to transfer to the complex world of investment.

On the Stock Markets, the monetary organizations favored the dominance of the technology sector, since the lower cyclical volatility meant a lower risk associated with the financing of high-growth business models.

It has also contributed to the meteoric rise of passive investment strategies: the more central banks suppressed volatility, the more they stifled dispersion and opportunity within asset classes and across regions, making it harder for active managers to outperform. .

In addition, they have encouraged the concentration of capital in the most profitable assets, especially those from the United States, since less cyclical volatility has meant a more reliable leadership in the market.

John Butler, Wellington Management's macro strategist, and Amar Reganti, the firm's fixed income strategist, point out that central banks now "can no longer be the stable and reliable brakes on the cycle."

In such an environment, monetary policy becomes more volatile, with a greater likelihood of over-tightening in recessions and overstimulating in upswings.

“They become a source of volatility.

And in that scenario, macro stability decreases.

The business cycle will no longer spend most of its time in a static state.

Instead, it is likely to oscillate frequently,” Butler and Reganti explain.

A less stable macroeconomic environment for the European and US economies is also a major change for the investment world.

The implications should be steeper yield curves than in the past, wider credit spreads and lower equity valuations, especially for growth stocks more sensitive to the discount rate applied to future earnings.

Furthermore, some countries will need to rely more on fiscal policy tools than monetary policy to address the challenges they face.

There will be long periods in which growth and inflation move in different directions, as they did during the 1960s, 1970s, and 1980s.

And that can have a destabilizing influence on the correlation between fixed income and equities, so that bond yields may no longer be a very effective hedge against equities.

Finally, reduced market liquidity and increased macroeconomic volatility may make the investment landscape more complex and fluid – that is, more difficult to navigate.

There will be greater value (and potential benefit) in being more agile and liquid with asset allocation,