A check list for the coming year
On this occasion, it is an excellent opportunity to carry out some long-term thinking as well.
What are the prospects for 2023? It is always worth reading the year ahead reports from market strategists and economists, albeit with a pinch of salt.
If you wisely kept last year’s copy, check the accuracy of their predictions and whether they are merely repeating previous messages, for example ‘it is time to buy equity, especially EM and China’.
‘Scars’ of the energy play will linger in 2023
This year’s raft of reports understandably propose a year of two halves, either a short-term equity market rally before further pain ahead, or an approaching trough in prices as a suitable entry point to put spare cash to work.
Some analysts focus more on central banks finally pivoting away from monetary tightening towards easier policies. An alternative view places more emphasis on the pressures on company margins, looking for a trough in profits and better valuations.
The choice depends on discerning the nature of the approaching recession, its length, depth and the appearance of new inflation shocks.
Now is also a good time to take some, admittedly complex, decisions about the make-up of a portfolio for the middle years of this decade.
There are questions to consider about the next investment regime, in terms of the inflation outlook, the interaction between fiscal and monetary policy, the transformation in asset valuations, higher political risk premium, or the inexorable rise of ‘green issues,’ to name just a few.
The inflation regime is paramount. CPI may be peaking, at last, but we still face a medium-term inflation cycle rather a ‘transitory’ phenomenon.
If economists and central banks are correct, and they do not have a great track record, then inflation will be well away from target during at least 2021-24. Does the world thereafter return to a low inflation regime?
More climate change shocks, less reliance on cheap Chinese manufacturing, the lingering effects of the pandemic on employment, a rebalancing of ‘labour vs capital’, high public sector debt burdens, all these are individually small factors but cumulatively suggest that inflation could be higher and more volatile in coming years.
Investors also need to consider how portfolios will react to the new relationship between monetary and fiscal policy. After years of zero or negative interest rates, central banks aim to return to positive real rates, and roll back their dominant role in underpinning sovereign bond markets.
Conversely, governments are shifting to much easier fiscal positions to offset recessionary effects. Corporate, household and government debt levels and the ability to service them will become more significant factors.
Markets looks set to reward fiscal discipline, and punish indiscipline as the UK government discovered.
Private markets to face reality check in 2023
Many asset valuations have rebalanced as the era of low inflation and ultra-easy monetary policy ended, notably equity and bonds vs cash but also public vs private and value vs growth. Over time a classic 60-40 equity vs bond portfolio shifted inexorably towards 70-30 or even 80-20.
The question to consider is when to buy fixed income, how quickly to return to the old balanced stance.
This partly depends on where next for bond-equity correlations, which comes back to the inflation regime.
The depth of the 2023 recession will also matter for the choice of liquid public vs illiquid private assts. We have been reminded in no uncertain times that diversifying portfolios is not easy.
Value needs a trigger to release it. UK equity would be a prime example.
Whilst the prospects for many FTSE 100 stocks will primarily depend on global economic growth, the fortunes of many FTSE350 stocks are linked to the domestic economy.
If the forecasts from some quarters are correct, for example the CBI warns of a ‘a decade of lost growth’, then severe pressures will appear on some company margins. Despite the UK long being a cheap market, the FTSE All Share index has in essence been flat for the past five years, under-performing its overseas counterparts.
Last, but not least, long-term portfolio construction must take more account of complex political and environmental issues.
The outcome of the Russia-Ukraine war remains uncertain, with all that means for energy prices. Growing US-China tensions are likely in the run up to the 2024 Presidential elections.
ESG regulation will become ever more widespread.
Even for those investors who are not concerned about trying to measure and reduce Scope 1-2-3 emissions, or fund the global energy transition, they should consider how climate change could lead to stranded assets or major losses in bank loan books.
The coming year is a good time to rebalance portfolios.
Yet this is not a return to the norms of the early 2000s.
State intervention is back in a way not seen for decades, debt sustainability is a much greater concern, portfolios need to include an ESG overlay, and valuations suggest the forward performance of equities is likely to be below the past two decades.
Good luck and good judgement for a happy new year!
Andrew Milligan is an independent economist and investment consultant and board adviser to Devlin Mambo
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