2022 was a difficult environment to navigate. Inflation was a concern coming into this year and the onset of the war in Ukraine added fuel to the fire. What followed was Central banks of western economies, starting with the Feds, introducing a series of rate hikes to cool prices which led to recessionary fears. Amidst all these challenges this year, fixed income which is an effective source of diversification within portfolios has disappointed as they were unable to limit the drawdowns investors were experiencing. Now that we are rounding the bend into 2023, investors would perhaps be wondering what would be in store next year. In the following sections, we will discuss our views on the macro environment going forward and list out the investment opportunities in the marketplace.
Chart 1: Equity market performance YTD. Source: Bloomberg
Chart 2: Bond market performance YTD. Source: Bloomberg
Our thoughts for 2023
To begin, let’s address the elephant in the room: Recession. Recession in the world’s largest economy has been at the crux of the topic amongst market participants as the Feds began their rate hiking cycle – historically, a Fed hiking cycle has led to a recession occurring and one indicator that is somewhat a reliable predictor is the yield curve. On this note, we would like to draw the attention of our platform’s investors to the yield curve.
In April, the well-known curve spread (2year/10year yield) inverted for the first time since 2019 and has remained inverted for the year – an inverted yield curve where rates on short-term government debt exceed those on a longer-term debt has signalled that a recession may be round the corner in the past. Additionally, the US dipped into a technical recession in the first half of the year which further supports market participants’ recessionary fears – we have argued earlier on in the year that the US economy will not experience a full-blown recession in 2022 and our thesis has been proven right as the US registered strong GDP growth in 3Q22.
Chart 3: Rising rates have resulted in the yield curve inverting in the past, signalling a recession to occur. Source: Bloomberg
Heading into 2023, we hold the view that the US holds a chance to narrowly avoid a recession. Bolstering our view are two factors. Firstly, the labor market remains sturdy as compared to the 1970s and 1980s when unemployment ticked up sharply due to Central Bank tightening – unemployment today only rose roughly to pre-pandemic levels and there are 6.3 job openings per unemployed person. Secondly, with inflation showing signs of slowing, real personal income and real disposable income adjusted for inflation should increase. Combining the factors mentioned, we believe that consumption which contributes about 70% to US GDP should remain resilient and hence the nation should be able to register muted growth.
Chart 4: US job openings and labor force participation rate provides a sanguine outlook for the job market. Source: Bloomberg
Chart 5: US consumers spending remains resilient. Source: Bloomberg
Where do investment opportunities lie?
Broadly, we hold the view that the worst of the de-rating is behind us. However, a significant re-rating in equities would require a shift in Central Bank rhetoric which we deem unlikely in the first half of 2023 as inflation remains above the 2% target– the Feds have signalled that they might slow the pace of interest rate increases in December 2022 but stressed that borrowing costs will need to keep rising and remain restrictive for some time to quell price pressure. Regardless, the case for long-term investing is still very much intact. In our opinion, Japan is the top pick from a geographical standpoint while at a sectorial level, we continue to favor the financial sector. Alternative investment-wise, investors can look to invest in commodities.
Japan: Re-opening boost to support equities
Japanese equities are one area we believe market participants can look to despite experiencing a challenging year thus far – on a year-to-date basis, the Nikkei 225 index is down almost 17% at the time of this writing as gleaned from chart 6.In our opinion, factors there are several factors that will uplift the nation’s equities moving ahead. Firstly, macro data are displaying encouraging signs. Record new virus cases in 3Q did not depress the labour market. In fact, it appears that the labour market is tightening which suggests that the Bank of Japan (BOJ) could be a step closer to achieving the sustained wage growth it seeks to aid spending in an environment where prices are gaining. Furthermore, retail trade has also risen 4.2% in October, growing for the eighth consecutive month – resilience in consumer spending in the face of rising inflation and a weak yen was likely thanks to the strength of the labour market.
Chart 6: Nikkei 225 performance YTD. Source: Bloomberg
Chart 7: Japan labour market appears tight. Source: Bloomberg
Secondly, Japan has embarked on a different policy path from western economies. Instead of raising rates to cool price gains, the BOJ is sticking with its yield-curve control to support funding for firms until the economy returns to pre-covid conditions. Prime Minister Fumio Kishida on October 28 ordered an extra budget of 29.1 trillion yen to fund an economic stimulus package with the goal to cushion the impact of rising prices on consumers as well as keeping economic growth afloat. Additionally, the stimulus package will also offer corporates more incentives to increase wages and prepare the economy to capitalise on the currency’s weakness. With this stimulus aid in place, spending and wage growth will receive a boost in our view.
Chart 8: BOJ Maintains an accommodative policy stance. Source: Bloomberg
Chart 9: Retail sales remain in positive territory for the bulk of the year. Source: Bloomberg
Lastly,now that the Japanese government has brought back tourism with steps such as the removal of the pre-arrival PCR test requirement and restoration of visa exemption arrangements that existed for short-term stays before the pandemic, a revival in tourism will certainly benefit the Japanese economy – According to a report by the World Travel and Tourism Council (WTTC), Japan’s Travel and Tourism sector contributed 7.3% to GDP in 2019 and supported 5.8million jobs
The stars have aligned for the financial sector
As mentioned above, the Feds have reiterated that rates will continue to rise despite inflationary pressures slowing – a swift return to the subdued readings before the twin shock of the pandemic and the military conflict in Ukraine is unlikely. In consideration of that, the financial sector has much to gain in a world where rates are on an upward trajectory – banks are a prime beneficiary of higher rates as it leads to higher net interest margins and therefore expansion in profitability.
Chart 10: rates and performance of the financial sector move in lock step. Source” Bloomberg
Outside of banks, life insurance companies will also profit from higher rates – many life insurance policies involve guarantees and therefore a majority of the products are invested in treasury securities to avoid high risk or volatilities. (While life insurance companies hold a majority of their investments in low-risk investments such as treasury securities, they are generally less sensitive to higher rates as they continuously reinvest dividends proceeds into higher-yielding bonds.) Additionally, consumers will also have an added incentive to buy a life insurance contract because of the larger returns received, contributing to the earnings of these companies.
Chart 11: Insurance companies stand to gain in a rising yield environment. Source: Bloomberg
Investors who are looking to allocate some of their monies into the financial sector can look to the Blackrock World Financials Fund USDwhich invests at least 70% of its total assets in equity securities of companies whose predominant economic activity is financial services globally. The fund is managed by Vasco Moreno who is a specialist with 28 years of experience investing in the financial sector and his team of more than 20 Financial and FinTech analysts worldwide.
Capitalising on the commodity upcycle
This year, we witnessed yet another rally in commodity prices as the Russian invasion of Ukraine added additional stress to supplies which are already struggling to meet demand – Russia and Ukraine are both exporters of commodities. That said, prices have cooled off over the course of the year but remain elevated compared to the period before the military conflict broke out. In this vein, we hold the view that there is still more to gain from investing in commodities in the long run.
China has rolled out policy support to ensure stable economic performance. The initiative sets the prospect for higher commodity prices due to the nation’s position as a dominant buyer of metals – the fiscal policy will loosen to accommodate growth objective, which includes infrastructure spending that requires a large number of metals such as steel, iron and copper ores.
Chart 12: China’s credit growth leads to higher commodity prices. Source: Bloomberg
Outside of China, demand is expected to rise as well. For example, the European Union (“EU”) have committed to huge fiscal spending over the next few years, with a sizeable portion of the EU Nextgen fund tilted towards climate-specific spending – the transition to green energy will unleash an unprecedented demand for metals in the coming decades.
Moving to the supply front, commodity supply was already tight and was going to lag demand due to structural under-investment, weather and labour. However, with the war in Ukraine, supply chain issues have been magnified as sanctions are affecting Russia’s ability to export key base metals which is crucial to meet the burgeoning demand from various nations in the years to come
For investors who wish to have a slice of the pie, you can look to the Threadneedle (LUX) Enhanced Commodities AU USD fund.The fundis managed by David Donora and Nicolas Robin who combines more than 50 years of experience in the industry with an investment objective to seek capital appreciation which is directly and indirectly linked to commodity markets.
Investment philosophy-wise, the team’s fundamentally driven investment process which aims to generate outperformance, implements both active weights (two-thirds of the alpha is generated via active weighting decisions such as rebalancing of weights driven by the investment process) and curve positions (one-third of the alpha is generated by capturing volatility and movement in the term structure) as it seeks to maximize performance outcome within the tracking error budget constraint.
Access and invest in over 1,000 funds distributed by Tiger Brokers. Go to the “Quotes” section on the app and slide the top bar to “Funds” to explore the full suite of funds we have on Fund Mall!
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