Bracing for uncertainty? Key trends to lookout for in 2023

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2023 Market Outlook

As we move into 2023, investor hopes have been bolstered for the year with latest inflation numbers coming in below expectations for two consecutive months, signalling that the end to the rate hike cycle may not be far off.

High & Falling Inflation

The headline inflation rate or CPI in the US slowed for a sixth straight month to 6.5% in December of 2022, the lowest since October of 2021, in line with market forecasts. It follows a 7.1% reading in November. On a monthly basis, the CPI flattened, following four consecutive months of increases, and compared with a rise of 0.1% in November.

The Fed Policy

The Fed’s meeting minutes from their Dec 13-14 policy meeting was released earlier this month. The meeting summary stated – “Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time,”. In essence, this meeting primarily reaffirmed their current stance of continuing to control the cost of credit (interest rates) to control inflation as policymakers were worried that pace of price increases were expected to run faster than anticipated. The minutes also reflected that no FOMC members expect rate cuts in 2023, despite market pricing.

Recession Forecast

While the consensus views on the odds of recession in the next 12 months have increased to 65% post the latest FED meeting minutes, analysts at Goldman Sachs have forecasted much lower odds at 35% with hopes of a softer landing. Leading indicators such as the labour market continue to remain strong with unemployment rates below 4%. Overall, even though the probability of a recession, hopefully mild, has increased, the broader economy is still in flux and we are in better control than before.

What this means for your investment strategy

As we look forward to the new year, we’ve identified some trends that individual investors could take on and adapt their investment strategies.

1. Return of the 60-40 portfolios

Falling markets have brought about a silver lining. Government bond yields and credit spreads have increased sharply while equity valuation multiples are now at or below average levels seen over the long periods. The combination of rising bond yields and falling equity valuations means that expected returns for multi‑asset portfolios have moved considerably higher.

The global 60/40 portfolio has a current nominal expected annual return of 7.2% vs 3.3% in July 2021 and a real expected annual return of 4.4% vs 1.2% over the next five years. Therefore, investors looking to achieve a particular nominal level of returns may do so with lesser allocation to risky assets.

2. Diversification into return enhancing asset classes

While the traditional 60/40 stock-bond portfolios have been the foundation of investing for decades, a continued inflationary environment still poses a challenge.

Expanding asset allocations to other asset classes including commodities, REITs, and international and emerging-market equities, in addition to bonds, can help to diversify further, reduce volatility and increase expected returns.

3. China – the return of the bull?

Investor sentiment on China also turned bullish in the last few months. The MSCI China Index has rallied 52% in US dollar terms from 31 October to 19 January. Over the same period the currency, the renminbi, has advanced by 7% against the US dollar.

The rally has been sparked by hopes for a faster exit from the “zero-Covid” policy as well as the government’s recent positive Covid and property market measures. This is truly a turn on the corner given the strong underperformance of Chinese equities YTD which was led by local lockdowns that weighed on the recovery in the property sector despite continued policy easing.

4. Be patient. Stay Invested.

There have been multiple bear markets (>20% decline in the stock market) in the 150+ year history of the US stock market, averaging once every 3.5 years. But, in each case, the market eventually recovered and went on to new heights.

Despite the downturns, some of which were quite long and severe, $1 invested at the end of 1870 grew to $20,514 in real terms in 2022. This is a real annual rate of return of 6.8%. More recently, if you had invested in the S&P 500 from the market peak of 1 Jan 2008 till the end of 2022 (going through the great financial crash in 2008, covid crisis in 2020 and the bear market run in 2022), your nominal returns would still be 254.01%, at an annualised rate of 8.79%.

While we certainly don’t have a crystal ball into the future, history tells us that building wealth successfully is not about being able to predict the dawn of a ‘lost decade’ or time the lows, but the ability to be patient. Stock markets have been very generous to investors who can get through such periods of decline and invest for the long run.

To find out more about how Syfe investors invested in 2022, check out our 2023 Investor Trends.

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