5 January 2023
If 2021 was all about inflation and 2022 was all about interest rates, we see 2023 as being all about recession. However, we also see the year ahead as being about markets anticipating the recovery that will surely follow.
Ben Funnell, Head of Investment Solutions, outlines CCLA's key viewpoints on economic recession and market recovery. To read the full article click here.
Economic recession
Economic contraction is widely expected and is likely to be especially marked in the UK, where recession could be protracted despite a tight labour market.
The UK economy looks to be most susceptible among the G7 to a recession that has probably already started, given higher interest rate sensitivity and more hawkish fiscal policy. Nonetheless, inflation should slow to 3-5% range on UK CPI, and the Bank of England is unlikely, we feel, to have to raise interest rates more than another 100bps to 4.5% or so.
Europe’s economy is also set to shrink in the face of energy supply and pricing issues associated with the war in Ukraine, as well as weakening export demand.
In the US, which dominates the global economy, recession also appears likely, but it will probably take longer to arrive and be relatively short and shallow.
- An inverted yield curve, historically a very reliable indicator, is among a range of measures clearly signalling that the US is heading towards contraction but the jobs market has yet to respond to tougher conditions.
- Meanwhile, high levels of personal savings are available to support consumer expenditure; and resilience is further helped by the US mortgage market which does not require homeowners to refinance at higher borrowing rates in the way that we are seeing in the UK.
US inflation will fall substantially from current levels over the course of the year, but we believe that the days of benign disinflation are firmly behind us and that we are entering an extended period of higher and more volatile inflation than many investors are used to.
Market recovery
In the US, equities are much more reasonably priced than at the outset of 2022, and in other major markets they are already looking remarkably cheap. Nevertheless, we see scope for a further downturn in equities in the coming months, as inflation and weakening demand take a toll on corporate earnings which hasn’t yet fully been priced into valuations. As we head further into 2023, though, we would expect to see markets begin to move upwards in anticipation of economic recovery.
Bond yields have risen sufficiently to present some attractive opportunities for the first time in many years. The onset of recession and the policy response of central banks can be expected to push yields lower in due course, bringing the potential for capital gains to add to stronger nominal income in the hands of bond investors. In the corporate bond market, credit spreads are now wide enough to tempt some funding away from equities.
For alternatives such as commercial property, infrastructure and contractual income assets, valuations will remain challenged by higher bond yields. However, this does not in itself damage the underlying cash flows and fundamental characteristics which make these assets attractive diversifiers for long-term portfolios.