Outlook for Global Equities in 2023

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Amber Sinha, CFA

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Amber Sinha, senior portfolio manager at global Equities at CIBC Asset Management.

Early on in 2023, it seems like a recession is pretty much a given. I think it is now the view of the consensus when it really wasn’t, even six months ago. People were hoping for a little bit of a mild slowdown, et cetera. But I would agree, I think the commentary now is largely that we are in for a recession, so how do the markets look? And if I’m being frank, it’s not great.

I think 2023 will bring us multiple headwinds. I think the biggest being the inflation scare. And inflation is having a negative effect on several fronts. One, people’s wage growth is not being able to keep up with inflation. As a result, people have to accept declining incomes in real terms. Interest rates have been increased here in the States and in Canada, we’ve seen hikes to the tune of 4%, which is fairly big in magnitude.

Last year was just about the headlines with the Fed or the Bank of Canada rates increasing. This is the year when we actually see it impact consumers. So whether it’s on mortgage payments, car payments, anything that has variable rates attached to it, I think certainly will be a little bit more difficult for people in 2023. And then there’s also the demand for products, which we mustn’t forget was very strong through the Covid years for mobile phones and televisions and couches. And I think the very purpose of the Fed or the Bank of Canada raising rates is to beat down the demand for these products. So 2023 would probably be a year with the weakest demand for such products over the last two or three.

So you put together the higher inflation, especially higher than wage growth, interest rates have risen dramatically, plus the demand side looking a little shaky, again, doesn’t look great for the equity markets.

I would say, however, that all is not lost. We have had the MSCI World decline to the tune of 20% last year. So 2022 was a fairly negative year with the markets. Again, if you look at the MSCI World as a proxy for the global stock markets, we lost 20%. So obviously, some of the weakness that’s yet to come in 2023 is definitely being reflected in the stock prices.

There are also areas where valuation excesses have built up over the years, again, because of near zero interest rates. One popular gig sector that’s identified here is technology, valuations got too broad and we have seen some of the valuation excesses from the technology sector come off in 2022. We can’t say for sure if it’s been completely cleaned out, but the valuation excesses definitely look a little more well behaved now than they did starting 2022.

The one thing that also concerns us is the earnings expectations for 2023 do not reflect what we expect, which is actually a negative development in earnings growth. I see that happening sometime during the course of the year, and I think at that point when consensus expectations for earnings starts to decline, that would make us a little bit more comfortable in the market. So last year was more about the headlines with the inflation, interest rates, what have you.

This is the year when we see the symptoms of that. So we will see increasing unemployment, we will see some of the markets that are extremely tight loosen up. And those I think will be the real symptoms of a recession that we’ll see in 2023. And again, when those numbers peak out, the market also often bottoms. So when we see the symptoms, it’s probably a good sign to be in the market. But I would say for now it seems a little too soon.

In terms of the regions that would be affected more so than others for 2023, I guess we’re just starting out there. So it’s a little bit of an art plus science, I would say. The obvious one that stands out is Europe. And I wouldn’t be surprised if indeed Europe is the most difficult place to be in 2023. A few reasons for that. I would say even on a good day, Europe among the different regions of the world, does have the weakest fundamentals, the weakest demographics. So those are challenges for the continent that they have to grapple with for years to come. But we are not even in a great economic environment right now. So it just makes those issues even more profound.

To that we can add the fact that the markets in Europe have rallied hard. So they have bounced from the lows of October 2022, quite strongly. In Canadian dollars, the European market is up close to 35% since October. Let it sink in… 35% since October. So we have had a rally, which is largely predicated on energy prices softening because of a warmer winter and not as much disruption to the market as expected from the Russian oil caps. So essentially, we’ve seen the market rally hard on not very much except for a warmer winter. So I think, again, the risks from evaluation point of view are building up in Europe.

Again, the things that I said which don’t look that great for 2023, inflation is the highest in Europe of any place. So again, this makes it even more difficult for them. The effect of increasing interest rates, Europe also happens to be the most leveraged continent. Some of the countries have consumer or household debt even higher than in Canada. So levels of debt are fairly high in Europe and it takes very little move in interest rates to start creating problems. So I think Europe looks vulnerable that way also.

Then let’s also not forget that there’s fighting right around the corner in Eastern Europe. And when there is a conflict of that magnitude between Russia and the West using Ukraine as a proxy, things can go wrong. So that’s certainly a risk that if it were to happen, hopefully not, Europe’s the closest to that region. So you put all that together with a 30, 35% bounce from the bottom, Europe looks the least exciting to us, I would say for 2023.

So what do we like, despite everything that’s going on? Asia would stand out as the region that can have the best economic outcomes. And again, so why does it seem that way? I would say China is a big factor. We expect the reopening in China to add a lot of momentum to the economy, the momentum that certainly has been lacking for the last two years. And we feel strongly about China. I mean the market was fairly favorable on China for 2022 as well, because the reopening was supposed to happen and it didn’t. In fact, the outcomes were just the opposite. We just feel more strongly this time around because the reopening is indeed happening.

Why it fizzled out last year is that people really didn’t expect the lockdowns to continue almost until the end of the year. Now we do know that the lockdowns are going away and going away quickly. So the reopening is happening as we speak, and a lot of economic activity in China, whether it’s on the industrial side, factories, manufacturing, even consumers, a lot of it has been held back over the last two or three years. So just unleashing that will help Asia as a region, not only China.

Asia also happens to be the part of the world where the reopening or lockdowns stuck around for the longest. So Japan, for example, allowed visa free travel for foreigners I believe just in October of last year. So if you look at Tokyo Disneyland, which is operated by Japanese company, Oriental Land, the attendance at Tokyo Disneyland would still be a small tiny fraction of where it used to be pre-Covid, whereas the Disneyland in California or Disney World in Orlando already seeing attendance back to pre-Covid high.

So I think Japan, Taiwan. We had one person from our team do a trip to Taiwan. We’ve been waiting to go there, but quarantine rules were just very stringent. You could finally go there only in November. So again, for much of 2022, a lot of Asia was essentially closed. And that seems to be opening and in a fairly irreversible way. So I think that’ll help not only in China, but also Asia as the entire region benefits from the reopening.

Again, the same approach in terms of what we like or do not like about regions. Unlike in Europe, Asia tends to have pretty clean balance sheets, whether it’s on the corporate side or consumer side. Consumer leverage generally tends to be fairly low in Asia. I think it’s just more of a cultural thing. So in an environment where rates are going up, an economy with lower leverage will tend to suffer less. So I think we like that about Asia. Also, the Asian economies generally tend to be faster growth economies. As a result, they have a structurally higher inflation. So while the inflation for us sitting here in Canada has gone from 2% to 7%, in some of these Asian countries it’s gone from 5% to 7%. So incrementally, it’s not that painful for people in Asia as it is for people here.

So I think they’re better shielded from rising rates. They’re better shielded from higher inflation. In fact, some countries, I would give the example of Japan, which has been fairly desperate for inflation and they’re now in the 3% inflation range. They would’ve loved to have that much inflation in the last 20 years, they just never did. So now they’re at that point where 2%, 3% inflation in Japan might actually take it out of the economic funk that it’s been for the last two or three decades. So I think inflation is not all bad in Asia. Leverage is well controlled and the China and [inaudible 00:10:05] agree it’s hard to ignore.