It’s time to get back into the investment mindset which when we left it a few weeks ago was a pretty ugly picture states Jay Pelosky of TPW Advisory.
A tough year ending on a tough note with one of the worst Decembers for stocks in some time. As we saw so often last year, historical truths were found to be lacking. December was one of the best months of the year for the US stock market and was just the latest in a long string of ahistorical performances.
Given that we are living in ahistorical times that should not really be a surprise anymore. And hey, Santa Claus brought his rally, didn’t he? Now we need to watch the month of January itself which often seems a bellwether for the year ahead. We do think that 2023 will be a year of gradual stability which should allow for more traditional relationships to hold up as we move through the year.
Today’s title, "Focus Forward", reflects that we are in a new year and as such, we can and should put last year behind us, good riddance, and move forward with our eyes on the horizon rather than the rearview mirror. We do have a few things left over from 2022 to consider; December’s jobs numbers, inflation reading, and Q4 earnings top the list. The just-in-jobs numbers came in slightly higher than expected with signs of cooling wage pressures—a good report on the first read.
As we enter 2023 we remain focused on our three keys for the second H theme (guess we need a new name): the pace of inflation’s decline in the US, the path of EU energy prices, and China’s ability to move off of Zero Covid. As we have noted over the past several months, all three have been moving in the right direction and at some speed (especially so in China’s case) thereby underpinning Q4’s risk asset rebound.
China’s shift from Zero Covid with zero outliers to the New Year’s Eve pictures of completely jammed Chinese city centers was certainly striking. It has been a complete about-face the likes of which have rarely been seen on such a critical issue. We have just passed the third anniversary of the WHO’s declaration of Covid as a public health emergency and China has completely upended its approach.
So far, the new approach seems to be working with more reports suggesting the worst of the Covid wave could be thru the main cities by the end of the month as mobility indicators pick up sharply across the country. Month end also brings the Chinese New Year and travel websites have been inundated since Zero Covid was relaxed. This travel will undoubtedly lead to Covid’s spread throughout the country but then it will be through the worst many months ahead of even the most positive outlook two months ago.
China stock prices have reflected this positive perspective coupled with the growing sense that China will seek to grow at 5% or more in 2023, putting paid to the idea of a global recession (though one would never know it reading all the year ahead outlooks over the holidays—many of which read as if they had been mailed in months before—late and out of date).
My former MS colleague Stephen Jen, now of Eurizon, has been arguing for some time that external demand weakness and subsequent weak Chinese exports would force Beijing’s hand on Covid and that seems to have been exactly what has happened. Stephen notes that the US and China are desynchronized with the US slowing while China is likely to accelerate its growth profile. We share this POV and it underpins our no-global recession outlook.
Overnight suggestions that China will ease its famous three red lines in the property sector highlight China’s drive for growth and its recognition of the tie-in between housing and consumer demand. Given the Chinese consumer has been locked up for roughly three years and has amassed $2T in excess savings (McKinsey) we expect a strong recovery in domestic demand and foreign travel (Japan is a big winner here).
But it’s not just in China where things are moving rapidly and in the right direction. In Europe, the collapse in energy prices has been almost as dramatic as China’s move off of Zero Covid. Natural gas prices have collapsed by roughly 50% in the past month or so to levels last seen in early 2022, well before the Russian invasion. One will recall all the grim warnings about a freezing Europe this winter but instead one sees much warmer than normal weather, sharp reductions in energy usage, and a collapse in the price.
This bodes very well for Europe’s inflation outlook with December headline inflation reflecting this falling 0.3% M/M and up 9.2% y/y, down from over 10% in prior months. The core remains around 5% suggesting more ECB rate hikes. As we have noted previously there has been no sign of any wage price spiral even as unemployment levels continue to fall throughout Europe which in turn has underpinned the consumer and thus the economy (see November retail sales coming in well above expectations today).
Notwithstanding the potential for rapid falls in inflation if energy prices remain near current levels (some private sector folks are already cutting 2023 inflation estimates) we continue to expect ECB rate hikes to be more aggressive than the Fed this year, supporting the Euro. We expect any EU recession to be mild given its record low unemployment rate, fiscal spending, and regional investment around the semiconductor and clean energy spaces. Europe would also be a prime beneficiary of a strong rebound in China's growth.
The slowpoke of the big three has clearly been the pace of US inflation’s decline and while slow it is happening; we expect to get more evidence of that next week with December’s CPI which is likely to be the last major data point before the Fed meeting at month end. We remain in the camp that argues for a faster-than-expected fall off in 2023 inflation albeit without a recession, much as 2022’s inflation occurred without much in the way of real economic growth (though plenty of nominal GDP growth as we noted throughout last year).
Q4 earnings are also on tap and despite all the recession calls (most predicted ever) and all the SPY will fall sharply in 2023 outlooks, US earnings continue to hold up—especially on a bottom-up basis with net revisions trending up over the past several weeks. There is an overabundance of what could go wrong POV… we prefer to focus on what could go right.
As such, we are more focused on what companies say about the 2023 outlook than we are on Q4 results, and expect we are not alone in this focus. Given the valuation derating which occurred last year, it’s a US earnings decline that the bears need to see manifest to get that opportunity to gorge on stocks at 3200 or 3000 or pick a (lower) level.
We struggle to see it given that the US economy is growing at roughly 3.5% or so according to the Atlanta Fed GDP now cast suggesting it will enter 2023 with an above-trend growth pace, not a recessionary pace. The trick of course is whether this growth outlook is congruent with declining price pressures. We think it can be. We expect a flattish year for the S&P, a great setup for the ROW.
Our positive outlook for 2023 stems in large part from this idea that 2022’s headwinds are shifting to become 2023’s tailwinds; an idea that most have yet to cotton on to accept, or position for. Our Tri-Polar World (TPW) construct helps us develop themes like our three keys for the second half which in turn has helped us identify and position this shift in real-time.
Our TPW thinking has also allowed us to note the continued absolute and relative strength of the non-US equity markets which coupled with USD weakness reinforces the incipient shift to non-US equity leadership we have been harping on for the past quarter or so. In local currency terms Japan, yes Japan, was the best performing major equity market last year, followed by Europe and then the US dragging up the rear.
Within our global multi-asset (GMA) model portfolio, we remain OW a mix of DM and EM equity markets for the year ahead, supported by equity valuation, cheap currencies, under ownership (very visible in China, Europe, and Japan), decent momentum and the potential for rate cuts, especially in the EM space. EMs started the rate-hiking cycle and are likely to begin the rate-cutting cycle in the quarters ahead. We see a much greater likelihood of rate cuts outside the US than in the US this year.
