Last year was undoubtedly one of the most challenging years on record for financial markets. Central banks had only just removed the word “transitory” from their vocabulary and seemed poised to tackle inflation when Russia’s invasion of Ukraine sent another supply shock reverberating around the globe.
Being ‘behind the curve’ turned out to be an understatement for the predicament facing central banks and the subsequent synchronisation of global monetary tightening — the sharpest in decades — saw almost all asset prices head south in a coordinated manner.
"Despite the pessimism for equities in the first half, we see the opportunity for almost all asset classes to recover at some point in 2023.”
Global equities and bonds both suffered significant falls, in the order of 15 to 20 per cent. Although those invested in well-diversified, multi-asset portfolios were somewhat shielded from the carnage.
Looking ahead to 2023, ANZ Private Bank expects a material slowdown in global growth as 2022’s interest rate hikes finally come to bear. Our Global Market Outlook currently forecasts recessions for the US, Europe and the UK.
Australia is seemingly better placed to avoid such a fate. Supported by China’s reopening, sustained demand for commodities and a relatively weaker inflation pulse should provide the Reserve Bank of Australia with more options to engineer a softer landing.
With inflation likely past its peak in the US and Europe and the end of this tightening cycle in sight, ANZ Private expects the market’s attention to shift from inflation worries to growth concerns. The subsequent impact on corporate earnings and equity valuations will come into focus. Here, earnings forecasts still appear too rich for our liking and seem yet to fully reflect the broader backdrop.
Much like 2022, the eventual path for financial assets hinges largely on the reaction function of the US Federal Reserve. Will it blink in the face of deteriorating fundamentals or is it likely to inflict further pain on economies? This remains unclear. However, regardless of the outcome, for patient investors, there is likely to be ample opportunity in 2023.
This year ANZ Private highlights three broad potential scenarios for investment markets.
Under the first scenario, inflation comes off the boil, the growth slowdown is sharper than expected and the Fed and other central banks have the luxury of being able to cut policy rates to support the economy.
If this transpires, ANZ Private would expect equity markets to suffer if earnings begin to reflect a recessionary environment. Of course, if equities rebase, there may be scope to rebuild a sizeable equity position.
The second scenario would be more damaging for equities. Under this scenario, inflation remains stubborn and central banks are required to raise rates further than currently expected. If this transpires, growth would be undermined to an even greater extent. And equities would follow.
If this occurs bonds may also suffer but, with break-evens now at more reasonable levels, bonds would remain a more attractive investment across multi-asset portfolios.
The third and most unlikely scenario would see inflation recede somewhat, employment remain healthy and growth not falter as expected. Under this scenario the Fed may engineer a soft landing while holding the cost of funding at elevated levels.
Weighing up the likelihood of these alternatives, ANZ Private believes the risk-reward trade-off is skewed towards bonds, at least early in 2023. Any sustainable rally in equities is likely to come only once a new low has been tested.
This outlook led to changes to our portfolios in the second half of 2022, namely a reduction to our underweight to global bonds and a cut to equity exposure. Moreover, it determines why ANZ Private is positioned with a mild underweight to equities and overweight to cash as the new year commences.
Despite the pessimism for equities in the first half, we see the opportunity for almost all asset classes to recover at some point in 2023.
ANZ Private expects to remain defensive across portfolios in the first quarter until there is greater certainty on the outlook for growth and inflation OR central banks shift to a noticeably more dovish tone.
Market rallies may be an opportunity to sell into strength. Conversely a sustained sell-off prior to any pivot could provide an opportunity to go overweight equities, particularly as we approach the second half.
The second half may also see opportunities abroad if US dollar strength fades. A fading US dollar should support emerging market equities and could provide scope to add to our existing overweight to emerging markets, regardless of overall equity positioning at the time.
ANZ Private sees a better outlook for Australian shares relative to US equities in 2023. However, we maintain our current mild underweight for now. There is no rush to build this position given the expected weakness for share markets early in 2023.
In fixed income, ANZ Private’s current preference is Australian bonds relative to global bonds and sovereign bonds versus credit. Any shift into equities later in the year would likely be preceded by a shift to investment grade credit first and then possibly high yield.
Investment grade credit spreads are attractive and at this point in the cycle a quality bias remains prudent. A softer recession or economic recovery could be conducive to high yield, where the current yield embedded in these assets is appealing to say the least.
However, like equities, too many question marks remain. More certainty about the outlook is required before building a substantial position. ANZ Private encourages a long-term diversified investment strategy.
As 2023 commences, ANZ Private is positioned defensively across portfolios but recognises investors are likely to be well served by tactical changes throughout the year as market conditions evolve rapidly and opportunities present.
Click here to read the full 2023 Outlook report
Lakshman Anantakrishnan is Head of Investment Strategy, Private Banking & Advice at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
13 Jan 2023