The good news is that 2022 finally saw the world shake off the grip of Coronavirus as it transitioned from a pandemic to endemic (albeit it’s still causing problems in China). However, the past year turned out far more difficult for investors than might have been thought a year ago:
Despite these problems, global GDP is still expected to have come in at around 3.2% which is weaker than the 5% or so growth expected a year ago and down from 6% in 2021, but still reasonable as reopening and stimulus helped. And in Australia, GDP is expected to have been around 3.5%, lower than expected a year ago and down from 4.8% in 2021, but still reasonable. The growth slowdown saw a slowdown in profits. But the main problem for investment markets was the rise in inflation, interest rates and bond yields.
Investment returns for major asset classes
*Year to date to Nov. Source: Thomson Reuters, Morningstar, REIA, AMP - Global shares had a rough year with a plunge of 23% into October on inflation, interest rate and recession worries, before a rally cut losses. - Chinese shares led the weakness, not helped by its zero Covid policy, followed by Asian shares, given their exposure to China and cyclical sensitivity. US shares also underperformed reflecting its high-tech exposure & aggressive Fed tightening. - Australian shares outperformed, helped by strong commodity prices and a relatively less hawkish RBA. - Government bonds slumped as yields surged on high inflation & rate hikes. Australian bonds had their worst year since 1973 or the 1930s. - Real estate investment trusts fell with the surge in bond yields. - Unlisted property & infrastructure returns remained strong, being less sensitive to short-term share market and bond yield moves. - Home prices fell sharply reflecting poor affordability after a boom &, particularly, as mortgage rates rose, reducing home buyer capacity. - Cash and bank term deposit returns improved but were still low. - The $A fell with share markets on growth concerns and relatively aggressive Fed rate hikes into October, before a partial recovery. - Balanced super funds had negative returns reflecting poor share and bond returns. This followed very strong returns in 2021.
First the bad news: inflation is still way too high at around 7 to 11% in many advanced countries; tight labour markets risk wage-price spirals; central banks are still warning of more rate hikes; the risk of recession is high with inverted yield curves and weak confidence largely in response to rate hikes; the US has returned to divided Government with the risk of debt ceiling and funding standoffs; war continues in Ukraine; and tensions remain with China and Iran. Even Covid continues to disrupt – but mainly in China as cases surge as it reopens. These all suggest another volatile year and possibly continuation of the bear market in global shares.
PMIs are surveys of business confidence and conditions. Source: Bloomberg, IMF, AMP
However, there is reason for optimism. First, inflationary pressures may have peaked and are slowing rapidly (as reflected in our Pipeline Inflation Indicator): supply chain pressures have eased; demand is cooling; and labour markets are showing signs of topping out. In fact, it may only require a slight pull back in demand (to push capacity utilisation back down to normal & unemployment above the NAIRU – or non-accelerating inflation rate of unemployment, with the return of immigration helping in Australia) to further depress inflationary pressure significantly. This suggests inflation could fall faster than central banks expect in 2023. Note that this is more a guide to direction than level. Source: Bloomberg, AMP
Second, central banks are likely nearing the peak in rates. The Fed is already moving to slow hikes, but conditions are likely to be soft enough to allow it to pause from around March ahead of rate cuts later in 2023. Sure, its signalling more but just as its signals were too dovish a year ago its signals now are likely too hawkish! In Australia, we see the RBA as being at or close to the top (3.1% is our base case for the peak with 3.35% our risk case) as by February/March conditions are likely to be weak enough to allow a pause, ahead of rate cuts in late 2023/early 2024.
Third, it seems everyone is talking about recession for 2023, such that it’s a consensus call. The risk is very high (probably over 50% in the US and Europe) and this will likely keep markets volatile given the threat to earnings. But it may not turn out to be as bad as feared. - In the US it may just be a sharp slowdown or mild recession in 2023 – if the Fed starts to ease up on the brake soon and given the absence of other excesses that need to be unwound, eg, there has been no overinvestment in housing & capex and leverage is low.
- Finally, geopolitics may not be so bad in 2023: there are no major elections in key countries in 2023; the war in Ukraine may not get any more threatening; and the Cold War with China may see a bit of a thaw. Overall, global growth in 2023 is likely to be around 2.5%, well down from 6% in 2021, but not recession in aggregate. In Australia, growth is expected to slow to 1.5% in the year ahead. And inflation is likely to fall.
Easing inflation pressures, central banks moving to get off the brakes, economic growth proving stronger than feared and improved valuations should make for better returns in 2023. But there are likely to be bumps on the way – particularly regarding recession risks – & this could involve a retest of 2022 lows or new lows in shares before the upswing resumes.
Shane Oliver, Head of Investment Strategy & Chief Economist AMP Capital
THIS ARTICLE WAS RELEASED BY AMP CAPITAL 14 DECEMBER 2022, FOR MORE AMP CAPITAL UPDATES GO TO WWW.AMPCAPITAL.COM.AU Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.