A weaker global economy in 2023  gives cause for a cautious approach

Investment Policy, January 2023

A weaker global economy in 2023 gives cause for a cautious approach

The financial markets have been extremely optimistic and have arguably gone too far in the way in which they have priced in expectations of a monetary policy turnaround by the US Federal Reserve.  An upturn on the major equity markets of around 15% to 20% and a correction in the US dollar of almost 10% indicate this. However, a massive interest rate turnaround by Western central banks would seem premature, as inflation remains a long way removed from their target of 2%. Significant interest rate cuts are only likely following a global economic downturn, which would of course initially weigh on the still optimistic earnings estimates of the market consensus. In the event of a decline in corporate earnings due to an economic downturn, however, the environment for equities would become more negative, which is why we have no choice but to remain cautious in keeping with the bank’s motto of “security over return”.

Following the enormous rise in US key interest rates, in particular, the global economic outlook is becoming increasingly negative. The high interest rates (with three interest rate hikes of 0.75% in the US alone within a very short period) will not have an immediate effect on the global economy. Instead, their impact will be felt with a delay of six to twelve months. Moreover, core inflation excluding energy and food prices is set to remain far from the central banks’ target figure for some time to come, with this being true not only in the US, but also in the Eurozone. The outlook for the global economy remains very difficult, even without geopolitical risks. However, these are an added risk factor, as is the unresolved situation in China, the world’s second largest economy. Accounting for almost 25% of China’s total economic activity, the real estate sector is continuing to place a very heavy burden on the Chinese economy. Unlike in previous years, China is therefore not in a position to provide clear impetus for global economic growth, instead remaining a problem for the worldwide economy because of its supply chains.

Equities

The equity markets have been priced for perfection in recent weeks, posting a strong rally of around +20% as they work on the assumption of an ideal scenario. This means that the markets are not only anticipating that inflation will return to central bank targets on a sustained basis, but also that we will see solid economic and earnings growth. However, this seems almost impossible within the same period and therefore “too good to be true”. If inflation were to fall from its current figure of 7.7% in the US and 10% in the Eurozone to the central bank target of 2%, this would likely only be possible in the event of a massive economic downturn, if not a recession. In this case, however, corporate earnings would then collapse, which would hardly leave the equity markets unaffected. At present, equity valuations are more expensive again according to the important criteria. This is the case taking account of current earnings estimates. However, these estimates are likely to be too high, both because the economic slowdown means that turnover growth is being overestimated, while rising wage costs and increasing financing costs mean that cost pressure is being underestimated. While the earnings estimates indicated by the consensus view of bank analysts are always overblown at the turn of the year anyway, this time there could be the need for especially pronounced downward earnings revisions. In this scenario, the already unfavourable valuations of equities would then be even more marked. It therefore makes sense to adopt a cautious and rather defensive approach. We are maintaining an overweight position in the more defensive Swiss market in view of the global economic slowdown we expect to materialise in 2023.

We favour the defensive Swiss equity market in view of the global economic slowdown expected in 2023.

Gérard Piasko, Chief Investment Officer


Bonds

While global bond markets have also advanced in recent weeks, the rise of 5% has been less considerable than the 15% to 20% increase seen on the equity markets, meaning that they are also less expensive in terms of valuation. For the coming weeks, and indeed months, it will not only be changes in inflation that are important. Should the global economy slump more sharply, government bonds may not only post a better relative performance than equities, but also than bonds with a lower credit rating, i.e. those classified as “high yield”. If the economy moves sideways, corporate bonds could yield more in terms of total return thanks to their higher initial yield. In addition to inflation, the performance of the economy will also be an important factor, as will the communication and actions of the central banks. In light of existing uncertainties, a balanced and quality-oriented positioning can be considered. Given their relatively balanced risk/return mix, we continue to favour bonds with good credit quality or an investment grade rating.

Currencies

In principle, the coming US interest rate hikes will support the US dollar. However, should the US Federal Reserve be less aggressive than expected in its approach and the European Central Bank and Swiss Central Bank go further with their interest rate hikes than the US, the recovery in European currencies could continue. Nevertheless, the euro’s recovery against the greenback has been strong in the short term, which suggests a period of consolidation will now come. Overall, a neutral stance can be adopted for the next few weeks, as fluctuations will become more likely in view of declining market liquidity towards the end of the year. Relative to other currencies, the Swiss franc should be less volatile in the months ahead.

Commodities

For commodities, the balance between supply and demand will be very important over the coming months. On the one hand, in the event of a more pronounced than expected economic slowdown, declining demand would weigh on commodity prices. On the other hand, the global supply of most commodities remains below average by historical standards. We are maintaining our neutral positioning at present. For gold, which has performed somewhat less well compared to other commodities, the development of the US dollar will be important. It should not be forgotten, however, that gold has held up much better than both equities and bonds. It has thus fulfilled its diversification function, albeit to a somewhat lesser extent than anticipated.

Gérard Piasko

Gérard Piasko

Gérard Piasko is Chief Investment Officer and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years Chief Investment Officer of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Important legal information:

This publication is intended for information and marketing purposes only, and is not geared to the conclusion of a contract. It only contains the market and investment commentaries of Maerki Baumann & Co. AG and an assessment of selected financial instruments. Consequently, this publication does not constitute investment advice or a specific individual investment recommendation, and is not an offer for the purchase or sale of investment instruments. Maerki Baumann & Co. AG does not provide legal or tax advice. In addition, Maerki Baumann & Co. AG accepts no liability whatsoever for the content of this document; in particular, it does not accept any liability for losses of any kind, whether direct, indirect or incidental, which may be incurred as a result of using the information contained in this document and/or arising from the risks inherent in the financial markets.

Editorial deadline: 23 December 2022

Maerki Baumann & Co. AG
Dreikönigstrasse 6, CH-8002 Zurich
T +41 44 286 25 25, info@maerki-baumann.ch
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