HyperNormalTimes

Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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January 9, 2023

2023: No Predictions – Some Assumptions, Questions & Thoughts

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Methods for predicting the future: 1) read horoscopes, tea leaves, tarot cards, or crystal balls . . . collectively known as “nutty methods;” 2) put well-researched facts into a sophisticated computer . . . commonly referred to as “a complete waste of time.”  Scott Adams (AKA Dilbert)

Assumptions

Old False Assumptions –  If we cast our minds back a year, the consensus view of financial markets included the following assumptions:

  • We were in a V-shaped recovery.
  • The reopening trade was a thing.
  • Inflation was transitory.
  • Vladimir Putin was containable.
  • Globalisation was increasing.
  • Interest rates would not rise substantially.
  • A 60/40 portfolio offered diversification.
  • Nuclear energy was environmentally unacceptable.
  • The defence of Europe was primarily the US’s responsibility.
  • Boris Johnson would get re-elected in 2024.

In reality, markets had discarded most of these assumptions by the end of Q1.

New False Assumptions – A year later, markets now broadly assume the following:

  • Recession is inevitable.
  • Inflation has peaked.
  • Interest rates will remain elevated, but the Fed will pivot.
  • House prices will fall and possibly crash.
  • Ukraine’s war with Russia is winnable.
  • The energy crisis is over.
  • The $US will remain strong.
  • The UK will endure the harshest and most prolonged recession in the G7.
  • Crypto assets are dead.
  • General AI is imminent.

 

Questions

These assumptions may or may not endure through the year ahead. But, rather than join the over-populated pool of new year market predictions (Bloomberg surveyed 500 last week), it might be helpful to pose some critical questions investors should consider over the months ahead. (The list below is inevitably incomplete).

Economic Growth

  • Will the global economy continue to decline throughout 2023?
  • Will the US enter a significant recession?
  • Will China continue to open up post-COVID?
  • Will any further Chinese reopening be inflationary or deflationary?
  • How long will Europe remain in a recession?
  • Has European de-industrialisation become structural?
  • Has China’s period of structural growth ended?
  • Will China inevitably become the World’s most significant economy and dominant power?

 

Rates & Inflation

  • How quickly will inflation fall?
  • Will inflation fall to or below the 2% target?
  • Will we worry more about deflation than inflation?
  • Are we likely to see a double top in inflation in the 2020s, similar to the 1970s?
  • Will US employment levels fall in 2023?
  • If so, how quickly will US jobs be lost?
  • Will Fed policy rates peak/plateau in 2023?
  • If so, at what level will rates peak/plateau?
  • Will the ECB and BoE continue to match further Fed rate rises?
  • Will the Fed reduce rates in 2023?
  • If tight monetary conditions persist, what things might break?

 

Energy 

  • Is the energy crisis over?
  • Will oil prices be higher or lower during 2023?
  • Will Europe push up LNG prices again to refill gas supplies for next winter?
  • Will the switch to nuclear continue if oil and gas prices remain weak?

 

Geopolitics

  • What are the prospects for peace in Ukraine?
  • What are the chances for improved US-China relations?
  • Has globalisation paused, or is it in reverse?
  • Will the World move away from just-in-case and back towards just-in-time supply chains?
  • Is the worst of the semiconductor shortage now behind us?
  • Will the period of US$ strength reverse in 2023?

 

UK 

  • Will BoE rates de-couple from the Fed funds rate?
  • How quickly will UK inflation fall?
  • Will house prices crash?
  • Will UK recession be deeper and last longer than G7 economies?
  • Is there scope for tax cuts before the 2024 election?

 

 

Biases

We are Biased – Just because we have seen strong trends in 2022 of some unexpected things (inflation, interest rates, the US $) doesn’t mean they have to reverse in the year ahead. But our financial markets respond to how we think about these trends more than the trends themselves. Being human, investors have evolved biases, such as recency and loss aversion bias, which impact how we think about these critical questions. For example, we overestimate the continuation of recent trends and fear losses twice as much as we appreciate gains. And, of course, all the assumptions and questions we ask about the investment environment are subject to exogenous “black swan” (low probability, high impact) events, unknowable by definition. There is much scope for error.

 

Thoughts

The Future and Beyond – Here are a few thoughts about the game of 3D chess we must encounter to take realistic stock of the macro environment ahead as we turn over a new leaf on the Gregorian calendar.

Economic Growth – We are about to enter (or are already in) the most widely anticipated (and therefore the most prepared for) recession in history. However, there remains a non-zero chance that the US can still avoid recession, at least one of significant severity. A US “soft landing” has substantial implications for rates and the value of the US dollar. It might take much higher rates to tame. But as China reopens, markets have yet to determine whether this is deflationary or inflationary. The falling oil price suggests it’s deflationary. Yet this assumption can change. If it endures, it represents an exogenous boost to the fight against inflation. The consequential easing of global monetary conditions would primarily benefit Europe and emerging markets.

Rates & Inflation – Inflation is falling but remains elevated compared to recent decades. How quickly it falls and to what level are critical unknowns. Another unknown is the degree to which policymakers care. The Fed has a new attachment to the core and stickier PCE services measure, which is less impressed by falling commodity prices. A key measure of US economic resilience is its continued ability to grow jobs. Despite being below the peak, the US still created 200 000 jobs last month. Sufficient to counter the high-profile and increasing number of technology job losses. Such resilience implies that Europe will struggle to keep up with the Fed’s path of higher policy rates. The UK’s pension fund fragility forewarns of wider European fragilities. Italian debt is on many player cards for “breakage candidate” bingo should financial conditions remain tight.

Energy – Europe has reason to be satisfied with its response to the energy policy implications of the war in Ukraine. Despite playing havoc with existing global LNG supply chains and pricing, Europe’s storage tanks remain full. Germany’s floating LNG facility in Wilhelmshaven received its first cargo last week, only six months after the project launch, some 4-5 years ahead of the typical planning horizon. With most hydrocarbon prices near or below pre-invasion levels, it is easy to assume the worst of the energy crisis is now behind us. Again an assumption we could revise before the end of 2023. Russia’s invasion was not the cause of Europe’s energy crisis but its result. The solution to date has been costly but short-term. Europe’s tanks need refilling again for next winter, and Europe continues to under-invest in secure, dependable energy.

Geopolitics – Few analysts in February last year gave much chance for Ukraine to withstand the military might of the invading Russian forces. Some fear the risk of a vanquished Putin or the unknown consequences of who might replace him in front of Russian nuclear launch buttons. Today with the supply of more lethal offensive weaponry and a fuller appreciation for Ukraine’s defiant national spirit, the assumption is of a war Ukraine can win. However, even assuming this happens, we will not immediately revert to interdependent global supply chains. The Chips Act is a long-term statement of intent about US economic security, and it will take a generation for Europe to rely so heavily on Russian energy again. These realities suggest that the 2020s will see structurally higher costs as home, friend and near-shoring continue to counter capitalism’s search for lower costs.

UK – The prospects for a strong UK economic recovery look slim. But the degree to which recovery is anticipated remains slimmer. Indeed, no forecast for 2022 included the UK having three Prime Ministers. While the Sunak Hunt partnership is unlikely to survive beyond 2024, any Starmer-led replacement is also unlikely to be significantly distinguishable on economic policy. The Brexit vote has clouded the UK’s investment environment for seven years. However embarrassing, the Truss think tank experiment blow-up at least gave UK policymakers a sense of the financial parameters within which it is safe to operate. A new government that builds stability by broadly ploughing the same policy furrow as the current regime would make the UK look like an attractive investment environment. Jeremy Hunt slammed the financial brakes on very quickly in November. While the Pound has suffered its worst annual performance since 2016, it has enjoyed one of its strongest-ever rallies in November and December. The UK market remains good value relative to its history and its peers. A set-up that means things only need to stop getting worse for it to be more widely appreciated. Furthermore, the early indicators from last week are that the UK consumer is still spending (Next update) and energy prices are falling (good news for inflation and government spending).

AI – As a sanity check, I asked ChatGPT: What financial market predictions do you make for the future? The bot answered:

1. Central bank digital currencies (CBDCs) will become more widely used and accepted, especially in emerging markets.

2. Increased use of blockchain and cryptocurrency technologies in financial markets. 

3. The development of automated trading algorithms and artificial intelligence (AI) will continue to rise. 

4. The global economy will become increasingly interconnected as more countries embrace open trade and investment policies. 

5. Increased demand for socially responsible investments as investors become more conscious of their investments’ environmental and social impacts. 

6. Increased demand for alternative investments, such as private equity and venture capital, as investors look for higher returns than traditional asset classes. 

7. The emergence of new asset classes, such as digital assets, and increased regulation of existing ones. 

8. The development of more sophisticated risk management tools and strategies. 

9. Increased use of big data and machine learning in financial markets. 

10. Continued growth in the use of digital payments and digital banking services.

Certainly, this is an interesting list. While I suspect the wow over Open AI’s new chatbot exaggerates our proximity to general AI, its predictions are as useful as those churned out by the 500 brokers and money managers surveyed by Bloomberg last week.

Whatever unfolds during 2023, investors should remain flexible and ask these and other questions as old assumptions are disproven, and new ones emerge. May 2023 offer better financial outcomes than 2022.

Happy New Year.

Jeremy

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