2023 Q3 Outlook2023Q3Outlook

Overview

The global growth outlook for the balance of 2023 appears tenuous with a strong labor market and recent economic growth supporting the view that the US could avoid recession. Meanwhile, Europe must contend with rising interest costs, which are already weighing on Eurozone consumers, while weaker demand from China is a negative for manufacturing: 
 

• The US Fed announced a “hawkish” pause and signaled that it was likely not done hiking rates. Strong underlying price pressures suggest that core inflation will remain elevated, supporting the odds that policy rates will remain high. 
   
• On the inflation front, expectations are for a significant decline from last year’s levels. Weakening energy prices and more favorable base effects have already driven headline inflation in developed economies notably lower, although core inflation remains elevated. 
   
• Japan and pockets of Europe, where earnings growth and profitability are comparable but valuations are more appealing than in the US, are relatively more attractive. A still-hawkish Fed, stricter bank lending, negative business surveys, and high valuations in the US are therefore reasons to opt for a cautious investment strategy and favor themes like quality and safety. 

 

Executive Summary

Economic Outlook

• The global growth outlook for the balance of 2023 appears tenuous. Although a number of major economies entered a “technical recession” during the first quarter of 2023, the residual impact of COVID-related monetary and fiscal stimulus has kept demand robust.
   
• In the US, the strong labor market has helped the economy weather March’s regional banking crisis and May’s debt ceiling drama. Recent economic strength supports the view that the US could avoid recession. However, recession risks remain beyond the immediate horizon.
   
• European economies risk the prospect of the winter’s technical recession extending into the rest of the year. Rising interest costs are already weighing on Eurozone consumers, while weaker demand from China is a negative for manufacturing.
   
• Meanwhile, the Japanese economy received a tailwind in the first half of 2023 from strong consumption and business spending bolstered by the government’s ongoing easing of COVID restrictions.
   
• China’s eagerly anticipated reopening has been uneven in the first half of 2023. Consumption spending and industrial activity remain weak while the real estate sector, which had previously been an engine for Chinese growth, continues to struggle.
   
• On the inflation front, expectations are for a significant decline from last year’s levels. Weakening energy prices and more favorable base effects have already driven headline inflation in developed economies notably lower, although core inflation remains elevated.
   
• At its June meeting the US Federal Reserve (Fed) announced a “hawkish” pause and signaled that it was likely not done hiking rates. Strong underlying price pressures suggest that core inflation will remain elevated, supporting the odds that policy rates will remain high.
   
• Japan’s relatively slower pace of inflation growth has allowed the Bank of Japan (BoJ) to hold rates low, though new BoJ Governor Ueda announced a monetary policy review that sets the stage for a change in policy.
   
• With China’s economy struggling to regain its footing in the face of reopening, the People’s Bank of China surprised with a cut in lending rates in mid-June. Additional targeted policy support in the second half of the year is likely.

Market Outlook

• Global equity markets led by the US posted strong gains in Q2 as companies exceeded quarterly earnings expectations and communicated stronger outlooks.
   
• Driven by significant optimism around the prospects for AI, the performance of the S&P 500 year to date has been top-heavy, with mega-cap tech firms accounting for nearly all of the index's gains.
   
• While the forthcoming end of the Fed hiking cycle, economic resiliency, and optimism about AI’s impact are positives, the mosaic of forward-looking macro and market data is historically consistent with recessions and lackluster risk asset returns.
   
• A still-hawkish Fed, stricter bank lending, negative business surveys, and high valuations are all reasons to opt for a cautious investment strategy and favor themes like quality and safety.
   
• Forward PE multiples for US equities are currently at the most expensive decile over a 20-year history. Comparing the equity earnings yield to fixed income real yields, investors are demanding the smallest premium to hold risky equities since 2007.
   
• With comparable earnings growth and profitability but more attractive valuations than in the US, we find Japan and pockets of Europe relatively more attractive.
   
• While China’s reopening tailwinds have not materialized and returns have disappointed, renewed support by policymakers in China is a positive. A Fed pause might support emerging market equities, but slower global growth is a negative, especially for exporters.
   
• The intense investor focus on Commercial Real Estate has subsided a bit, but the problems still remain. Prices from market transactions will likely result in more accurate marks in private asset investor books, which could precipitate further selling and forced deleveraging.
   
• Commodities have had a difficult first half of 2023. Slower cyclical growth will continue to weigh on industrial metals and energy. Furthermore, China’s lackluster reopening has not provided the tailwinds for commodities that we expected.
   
• The conflicting outlook between fundamentals and sentiment prevents us from decisively planting a flag in either a bullish or bearish camp at the moment. Therefore, we believe it is appropriate to take only measured active positions in the major asset classes.