- The pieces are in place to potentially make 2023 a year of “normalization.”
- Lower inflation, synchronizing growth and easing policy trends should help.
- Recession, if it were to materialize, should be shallow.
Over the past few years, we have seen a bit of everything when it comes to the global economy and financial markets. The outbreak of the pandemic in 2020 and resulting shutdowns saw global stock markets fall more than 30% from peak-to-trough, then rally off the lows to near double (!) by the end of 2021. Through this period, we saw oil prices turn briefly negative (?!) in April 2020, leading headline inflation to hit 0% on a year-over-year basis.
Fast forward to this past year, U.S. inflation spiked to 9.1% in June as the lagged impact of extraordinary monetary and fiscal policy collided with a surge of demand associated with the broad-based reopening of the global economy. At the same time, the Russian invasion of Ukraine led to a spike in commodity prices with crude oil prices rising to over US$120 per barrel. All this leading to one of the most significant drawdowns in bond prices and similar drawdowns in stock markets this year as central banks ratchetted up interest rates to stave off inflation.
Lining up the ducks
As much as volatility is a feature of the global economy and financial markets, I cannot help but wonder if what we’ve seen recently is a bit excessive. The economy is in pretty good stead. Employment is robust and consumer and corporate balance sheets are by-and-large in good shape. The lagged impact of monetary policy tightening and the easing of fiscal supports this year will undoubtedly lead to a weaker economy in 2023, but this is clearly necessary to tame inflation. This tightening will work through the housing market and ultimately soften the job market. Not a great economic outcome, but when we compare it to the current state of financial markets, it’s hard not to feel a bit more optimistic about returns for stock and bond markets next year.
So, what would it take for 2023 to be a calmer year for financial markets?
Priority 1: Return inflation to lower levels
On this front, there is some good news. The S&P Goldman Sachs Commodity Index (GSCI), a broad-based indicator of energy, metal and agricultural commodity prices, is down more than 30% since June. Key measures of shipping and port activity have fallen significantly and are more in-line with pre-pandemic norms. Companies are starting to report an easing in backlogs of work and a rise in inventories. These are all positives in the effort to bring inflation to a more sustainable level, but much of the focus here is on the price of goods. A still-too-hot jobs markets is keeping wage price inflation higher and may prolong this bout of higher than anticipated inflation.
Priority 2: Synchronizing global economic growth
Much of the volatility we have seen in the global economy and financial markets has been a direct result of the uneven impacts of economic closings and re-openings and spikes in commodity prices. This was further amplified by the imposition of lockdowns in China once again this year. As China looks to gradually ease lockdown restrictions, we are likely to see a temporary divergence between a positive economic impulse in Asia and the negative economic impulse associated with weaker growth in the U.S. and Eurozone through the first half of next year. By the end of 2023, however, there is a possibility that the economic slowdown in developed markets will have eased, paving the way for a more synchronized expansion into 2024.
Priority 3: Letting off the policy adjustment gas pedal
The last priority is an easing in the hyperactivity we have seen from central banks and fiscal policy makers. The unwinding of easy financial market conditions has been painful this year – a severe hangover from the emergency-level policies central banks enacted to prevent a financial crisis during the pandemic and the prolonged re-opening period. As much as some of this adjustment was necessary, the pace of tightening has been significant when compared to historical tightening cycles and this creates the risk of a more significant slowdown in the global economy. Recent signs that central banks will migrate to a more “wait-and-see” approach in a few months will reduce the risk of a significant crash in the economy in 2023 but may also keep inflation higher than pre-pandemic levels longer.
I know it’s vogue to preach doom in the financial markets – it certainly gets more attention from the business media – and there will undoubtedly be surprises in the coming months. Yet as I look across these three requirements, there is definitely a window for us to look back on 2023 as a year of normalization in the global economy – as much as normal can be used in the context of an everchanging and sometimes chaotic economic landscape.
Our 12-to-18-month outlook is constantly evolving and for the first time in quite a while, I can confidently describe our tactical positioning within our portfolios as “light.” A more neutral outlook for the prospect for stock markets, a modest conviction that bond yields will ultimately end up slightly lower than current levels today and a fairly positive view on credit markets as the slowdown in developed markets is unlikely to generate anything more than a shallow recession if one were to arise. This gives us plenty of flexibility to take advantage of the opportunities that will inevitably rise in the coming months, albeit in, hopefully, a less anarchic manner.
For more information about the topics covered in this blog or your portfolio, please do not hesitate to contact your MD Advisor*.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.