At our annual Investment Symposium, investment teams from across BNP Paris Asset Management debated the macroeconomic themes with the potential to shape markets in 2023, airing diverse perspectives and exploring the implications for portfolios. We share their conclusions on the main topics for the year ahead.
Inflation – Above target, but easing
A panel of investment team members[1] expects inflation to level off. While energy prices are likely to remain high and volatile, base effects will kick in, helping to bring inflation down in developed markets.
Post-pandemic supply chain bottlenecks are being resolved, which should lead to a moderation in goods prices.
The pace of service sector inflation may take longer to slow because of wage growth and the pass-through from higher commodity prices, but a deteriorating growth outlook should ultimately result in an easing here too.
On growth, the boost to demand in the US and Europe from post-pandemic reopening effects is behind us, while the lagged impact of monetary policy tightening is starting to make itself felt in the economy.
With the US Congress split and many developed countries facing high deficits and higher funding costs, the fiscal tailwinds of 2022 are unlikely to be seen again. However, inflation is likely to remain above central bank targets. As a result, the panel agreed monetary policy in developed economies will tend to be restrictive, in the absence of a systemic crisis.
A key risk to the central scenario of easing inflation is wage inflation in Europe (see Exhibit 1). To date, wage growth has been more subdued in Europe than in the US, but the minimum wage rose in Germany in October, in the Netherlands in December and in Belgium in January. This will be an important risk to monitor in 2023.
More muted inflation means the environment for bonds has improved. Long-dated real yields in parts of the bond market now look attractive, while higher rates may have restored the hedging characteristics of fixed income relative to riskier assets.
Growth – Higher rates coming through
Overall, the panel foresaw a mild recession in the US and Europe in 2023. Some members argued that a soft landing was more probable than is currently priced, while others felt markets were too optimistic on increasingly fragile economies.
On the upside, corporate balance sheets have been in fairly good shape, with little sign of overinvestment in this cycle, while companies have been reporting relatively good earnings that are expected to grow further.
However, rate rising cycles, when they have been as aggressive as the US cycle has been, have historically led to recession. Although it hasn’t always been evident in market sentiment, nominal growth was relatively firm in 2022, so 2023 should be the year when policy tightening bites.
The cash piles households have been sitting on since the pandemic are dwindling and lending is creeping up, while conditions in the housing market will likely worsen.
Declines in equity markets in 2022 reflected a significant amount of pessimism: 45% of MSCI Europe stocks were down by 20% or more last year, and 20% down by 30% or more, despite many of these companies expecting to grow earnings in 2023. The panel was split on how realistic those expectations would prove to be.
Geopolitics – Tentative improvements?
On US-China relations, our regional specialists expect continued noise over the Taiwan Straits. However, it appears that both the US and China understand the red lines over Taiwan, and the meeting between Presidents Biden and Xi in Bali brought some relief.
The panel was more pessimistic about the outlook for direct relations between the two powers, citing the restrictions on advanced tech exports put in place by the US in October. These represent an escalation of the trade wars between the two largest economies.
On Ukraine, the panel saw a higher probability of de-escalation in 2023, expecting US and European counterparts to be asked to come to an agreement with Russia – though what that might look like is unclear.
These two high-profile areas of tension have shifted the geopolitical platform with regards to relationships among other regions, with the Middle East and the Asian subcontinent now collaborating on trade and energy supply in a way they haven’t in the past. It will be important to understand the implications of this shift in supply chains.
A flat-lining Chinese economy and the end of cheap gas made parts of the European market look un-investable in 2022. A resolution of the conflict in Ukraine would be a strong positive for the region. German industrial companies have significant exposure to China, so Beijing’s abandonment of its zero-Covid stance and reopening of the economy should be supportive.
US dollar – End of the one-way trade
The dollar was the prime beneficiary of the move higher in real rates in 2022. With volatility tapering off across asset classes and central banks appearing to be past peak hawkishness, the one-way dollar trade now seems to be behind us (see Exhibit 2). Some of the downward pressure on the currencies of energy-importing countries and regions has also eased.
In the near term, the market appears keen to price in a softer landing for many economies, with central banks pressing less firmly on the brakes, geopolitical tensions easing and China reopening. In such an environment, the panel expects the US dollar to weaken and currencies that are a play on global growth in general or China specifically to strengthen.
However, the risk still appears skewed towards recession in the second half of 2023, in which case the dollar could see a bounce.
China reopening – The main event?
With a full reopening underway, some panellists nonetheless felt that market expectations of strong support from a reopening in China for global growth in 2023 were too optimistic.
The de-rating of China in 2021 and 2022 means there are potential reopening plays across the market. The sectors that stand to benefit the most – travel and hospitality – already look strong in US dollar terms. Panel members saw opportunities in ecommerce and internet companies where positioning and valuations may have reached maximum bearishness.
Some on the panel expected more policy support for the troubled real estate sector, ending the 18-month downturn, although with not a sharp rebound. The return of local buyers would be an important potential catalyst for a recovery.
Conclusions
The economic outlook is weak and geopolitical risks persist, but our panellists are cautiously optimistic that 2023 will bring fewer shocks than 2022. With the rate rising cycle nearing its end and inflation looking more contained, the outlook for fixed income is attractive.
Our multi-asset investment team favours high-quality corporate credit over equities and high-yield bonds, arguing that corporate earnings estimates have further to fall. Some panel members were more bullish on equities or argued in favour of selected opportunities for stock-pickers.
Also read Investment Outlook 2023 – Investing in an age of transformation
[1] Individual portfolio management teams may hold different views and may take different investment decisions for different clients
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