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- Not an easy year, but one with alternatives
There could certainly have been duller times to take on the post of Chief Investment Officer at DWS. The forecasts for 2023 have to take account of more major structural disruptions and challenges than can be listed on the fingers of one hand: record high inflation; the end of ultra-loose monetary policy; the end of China as a deflation-exporting growth machine; the ongoing political attacks on global trade; demographic change profoundly affecting more and more countries; the costs (and opportunities) of decarbonization; and finally the Ukraine conflict, the further course of which is highly unpredictable.
But the outcome of the Ukraine war and the other aforementioned challenges are, at least, "known unknowns"[1] Capital markets always experience their worst slumps when they are confronted by unforeseen developments, black swans like Covid, when uncertainty is at its highest and negative momentum can build fast. From this perspective 2023 will struggle to outdo 2022 when the jumps in yields and key interest rates were the highest in decades. What precipitate that was, at least in part, the fact that a major European power triggered a major war for the first time since the Second World War, provoking the worst inflation spikes and worry about energy supplies since the 1970s. Tension between China and Taiwan also developed an unwelcome new dynamic in 2022. Of course, further "unthinkable" things could still happen in 2023. The high implied volatilities on the bond and currency markets show how nervous investors continue to be. On the stock market, too, even large-cap stocks are sometimes shocking investors with double digit moves in one day.
Capital markets always experience their worst slumps when they are confronted by unforeseen developments, black swans like Covid, when uncertainty is at its highest and negative momentum can build fast.
However, we are aware that central banks’ reaction function in the coming year is difficult to predict. The monetary guardians face the same challenge as all market participants: an inflation pattern that is very unusual in its constellation. [2] While we expect consumer price inflation to fall from 8.2% to 4.1% in the U.S. and from 8.4% to 6.0% in the eurozone, these rates remain worrying, especially as a broad range of forces are driving them, not just commodity prices, but also wages. The central banks' work is therefore far from done and we expect them to remain restrictive in 2023, even at the cost of recession.
The persistence of inflation is ultimately one of the reasons why we continue to believe equities are an essential part of every portfolio, even if they face a wide variety of headwinds. We see limited potential for further earnings growth as the biggest obstacle, as many sectors are entering the new year with very healthy profit margins already. On the valuation side continued high inflation rates and positive real interest rates (of around 1.5% in the U.S.) are likely to weigh. While the latter is bad for the gold price, we think the precious metal will benefit from high central bank buying, continued geopolitical risk, and inflation. In our opinion the dollar’s strongest phase should be behind it, especially against the euro.
Overall, we enter the coming year with appropriate humility but also cautious optimism. We expect nervous sideways trading on the markets and a continuing search for equilibrium in what is now a new world for monetary policy. We believe diversification will be back in fashion as bonds and equities both offer possibilities. We see a risk that investors might again act too hastily as they look for central bank turning points whenever an inflation or wage number looks a bit kinder. And markets might get ahead of themselves too on the recession threat – because just how long regional recessions will last is one of many uncertainties. It is, as ever, not individual data points that will determine the prospects for the markets in 2023 but likely the highly complex interplay of the numerous economic and political forces that make up the global big picture.
