Monday Espresso Podcast 3rd January 2023

[00:00:00] Sheldon MacDonald: It is the 3rd of January. Happy New Year. We can all do with a happy new year after the difficult year we suffered last year. Really across the board, it was, as I say, pretty difficult, we had equity markets down by way of example, the S&P almost 20% negative for the year, the Bloomberg Global Aggregate, that's an index of bond markets down 16%.

[00:00:22] Sheldon MacDonald: The one shining light really was the UK with the FTSE managing a small positive return. We spoke about that during the year, now part of the reason for that will be the weakness of sterling, which is positive for UK plc and also the makeup of the market here in the UK with energy being a high component and energy obviously being a, a strong contributor last year.

[00:00:44] Sheldon MacDonald: So, Nathan, what are we looking at for this year ahead?

[00:00:48] Nathan Sweeney: I suppose the big question people want to look at for this year is, will we see a repeat of what we saw in 2022 in 2023. Now, statistically, that is highly unlikely. So, if we look at the S&P 500 as an example, the market has fallen for two straight years, less than 10% of the time, and that's looking at data going back to 1928.

[00:01:13] Nathan Sweeney: So, on average, when you get a down year in the S&P, the following year, the market is up on average 12.6%. And the only time where you've had these back-to-back declines within the market has been when you've had major economic events. So, let's look at some of the examples we have. So you have, the Great Depression, obviously back in the thirties, World War II, and obviously the oil crisis in 1973 and 1974, and the dot-com bubble is the final example of this.

[00:01:46] Nathan Sweeney: So from our perspective, we would believe that a global shock of some kind or a major economic event would have to unfold for us to see a repeat. So we think the narrative starts to shift from inflation to recession and normally what tends to happen is when that recession comes in and hits the markets start to advance, cause everything is then priced into the markets.

[00:02:11] Sheldon MacDonald: Certainly, this recession that we are looking at now is yet to obviously be confirmed if we do have a full recession, globally, but certainly a well-flagged recession. So, you've gotta think that most of the, the bad news has already been in the price.

[00:02:26] Sheldon MacDonald: One thing, I just wanted to pick you up on that two consecutive years. One area where we have seen two consecutive years of underperformance has been China.

[00:02:33] Sheldon MacDonald: China last year down 22%, the first time in 60 years that that market has suffered two years in a row. Of course, there's a slightly different dynamic in the past year with Covid and so on, but a different dynamic for China in terms of reopening now. It seems clear that they are on a path to rationalizing the measures there. It seems like there may first be a headwind as they get over the initial wave of covid, but hopefully then a reopening boost during the course of the year.

[00:03:03] Nathan Sweeney: Yeah, so I think, you know, if you look at the playbook that we saw on this side of the globe when things reopened, basically quite good for the economy, so you see a boost to growth but the other thing which I think you'll have to watch out for within Asia is inflation.

[00:03:17] Nathan Sweeney: They haven't seen the inflation that we've seen on this side of the globe, and that's because they've had tight restrictions and lockdowns but once you reopen that economy, you're gonna have a huge amount of demand, a huge amount of demand for product and services, therefore, that increases the likelihood of higher inflation. So that's the one thing which we'll have to watch out for when considering that region as we move into 2023.

[00:03:40] Sheldon MacDonald: I think also we're gonna have to watch out for any hiccups that we get on the supply chain side. Now, I was just thinking back, supply chain issues were pretty much what we were speaking about when we led into last year and we are still speaking about the same issues, inflation that, that plagued us certainly through the early part of the year.

[00:04:00] Sheldon MacDonald: Now it seems that inflation is becoming less of an issue, certainly here in Western markets. We have seen in the inflation measures start to decline, key though, will still be unemployment and we will this Friday, see the jobs report in the US.

[00:04:15] Sheldon MacDonald: Now clearly there were some fairly high-profile layoffs at the end of last year, but so far unemployment still running at only 3.7% and that's pretty close to record lows.

[00:04:26] Sheldon MacDonald: And that'll be a key item for Jerome Powell of the Fed when he is thinking about what to do with rate hikes, going ahead. He's on record as saying the strong labour market is a, a key element for him.

[00:04:37] Sheldon MacDonald: It's one of the factors that's perhaps keeping inflation higher than it may be in the face of all the rate hikes that we've seen.

[00:04:45] Sheldon MacDonald: On the other hand, we haven't yet really seen the impact of the hikes that have already been put in place. They do work with a lagged effect. So, a lots still to play for a lots still for us to keep an eye on.

[00:04:56] Sheldon MacDonald: In terms of the rate hikes, your take on that, Nathan?

[00:04:59] Nathan Sweeney: Yeah, so you know, obviously we've seen a number of rate hikes throughout the course of 2022. Central banks are now getting to the end of that rate rising cycle, and that'll be a big positive for markets. So if you look at bond markets specifically, they seem to have bottomed and that was earlier in 2023, so around September time when you saw a clear sign that inflation was starting to roll.

[00:05:22] Nathan Sweeney: So, the expectation here is that we should see a much better year for bonds in 2023, and also equities in 2023.

[00:05:32] Sheldon MacDonald: Let's certainly hope so, for mixed asset investors, having the double whammy of both equities and bonds falling last year, certainly very difficult to take.

[00:05:40] Sheldon MacDonald: A rebound would really go down pretty well. So really the key items to watch for the year. It still seems that it's gonna be inflation, although here, as we've said, we're looking at the speed of the decline of inflation rather than the increase, we're looking at recession, will they, won't they, will we dip into recession, won't we?

[00:05:59] Sheldon MacDonald: And then increasingly looking at how things will recover post-recession as we move into a, a normalized world again. So as we say, let's hope for a good year. Let's cross our fingers. But we certainly think there's a lot to be positive about, and we'll speak to you about those in the weeks ahead. We look forward to that.

[00:06:19] Sheldon MacDonald: Thank you very much and happy New Year.