The ride for global financial markets might have been less rocky so far in 2023 than last year, but they have certainly had their challenges.
Most equity regions have made double digit returns year to date, despite the mini-banking crisis in March, the US debt ceiling crisis in May and growing worries more recently about stickier inflation and higher interest rates.
As the world moves towards the last quarter of 2023, what is the outlook?
In our most recent tactical reviews, we maintained our overall positive outlook on markets at a positive four out of five. Market sentiment is still divided between fears around the ultimate impact of inflation and high interest rates, and evidence of more economic resilience than expected. But the underlying tone of markets has stabilised.
One of the equity market highlights this year has been Japan, which reached a 33-year high in May
We are gradually increasing our exposure to equities as we see opportunities to buy them at better value in certain areas. Investors should also remember equities have proved time and again to be the best asset class to beat inflation over the long term.
We recently raised the ranking for European small caps back to a neutral three, in line with our now neutral view on European equities generally. Concerns over the domestic economy are abating as Europe continues to progress after the problems associated with gas supplies from Russia due to the war in Ukraine.
One of the equity market highlights this year has been Japan, which reached a 33-year high in May. New Bank of Japan governor Kazuo Ueda told central bankers at Sintra that economic growth and wages were picking up at home after decades of near stagnation. This structural shift in the economy has caught the attention of international investors for several months and helped to drive the stocks rally.
We struggle to get excited about government bonds, even when yields have risen to 400 basis points-plus
We continue to monitor Japan closely to see whether its positive run this year is over for now, or whether it is still worth moving to an overweight position.
Equity regions we are positive towards from a tactical viewpoint include the UK, Asia Pacific and emerging markets, all of which have been the laggard regions in 2023. However, we see the UK as being relatively cheap after being shunned by many international investors since the Brexit vote in 2016, while Asian and emerging market economies should benefit from strong and favourable demographics over the longer term.
On fixed income, we are more neutral. We struggle to get excited about government bonds, even when yields have risen to 400 basis points-plus, although this does mean they offer more diversification potential than in the ultra-low yields seen previously.
This year we have lowered our ratings on both high yield bonds and emerging market debt from a positive four to a neutral three. Previously, we had seen attractive spreads in both these sectors versus government bonds, but these have since narrowed.
We believe the chances of a recession are much lower than those reported in the media
The fixed income sector we are most positive on is investment grade bonds, for which we raised our ranking to four in our Q3 tactical review. We believe the spreads they now offer over government paper means the bonds of quality businesses are trading at good value.
In terms of the global economy, monetary tightening has continued this year, albeit less aggressively than last, but there is still uncertainty as to how much further there is to go. Headline inflation has fallen from its highs while core inflation, which excludes energy and food, has remained stable.
The key question for markets remains how far interest rates will go to tackle inflation, but nobody can say with any real certainty what will happen here. Central bankers stoked fears that monetary tightening would exceed expectations at their Sintra and Jackson Hole meetings this year of central bankers, saying it was too early to declare victory over inflation.
Non-runaway inflation does not crash economies, although it can make it more difficult for companies to operate profitably
However, the supply chain issues, Russia’s invasion of Ukraine and the poor harvests in mainland Europe last year that drove inflation in 2022 now seem to be receding, reflected by the falls in headline inflation this year.
Fears of a recession persist but they remain stable. We believe the chances of a recession are much lower than those reported in the media. We continue to believe that a mild downturn is more likely in 2023 than a deep recession because central banks will strive to avoid it, and the global economy remains on a solid footing.
Corporates continue to generate good revenue. Non-runaway inflation does not crash economies, although it can make it more difficult for companies to operate profitably. In the US’ Q2 reporting season, most of the S&P 500 companies exceeded expectations, with technology giant Nvidia notably smashing forecasts.
In the absence of big news, over-reliance on whatever the latest snippets of data or news is driving excessive volatility
One phenomenon we have observed in markets this year is that they have become fickle: in the absence of big news, over-reliance on whatever the latest snippets of data or news is driving excessive volatility.
Sentiment is still divided over inflation remaining stubbornly high, but the general situation not being so dire either. This uncertainty does mean, however, that financial assets can still be purchased at reasonable value, making now an opportune time to identify the positive potential in markets and put in place investments for the long term.
John Husselbee is head of the Liontrust Multi-Asset team
