For many investors, 2022 felt like uncharted territory. Surging inflation, slowing growth, war in Europe and escalating US-China relations combined to create economic uncertainty. Investors may be asking themselves how to position a diversified portfolio in the current climate?
We believe that last year’s difficulties have created a range of potential opportunities as well as risks for 2023. Our Wealth Outlook 2023 report – launched recently by David Bailin, Chief Investment Officer and Global Head of Investments, and Steven Wieting, Chief Investment Strategist and Chief Economist, of Citi Global Wealth Investments – provides expectations for the coming year and thereafter.
Citi Latitude invites you to join David and Steven as they examine market scenarios and potential opportunities for 2023 and beyond in an engaging session, and observe its five key actionable takeaways.
The post-COVID economic boom of 2021 has given way to a bad “hangover” in 2023. But as with any day-after pain, today’s headache should not last. After a turbulent 2022, unsurprisingly, many investors may find it difficult to imagine a recovery. However, we believe change for the better will come in 2023, even as global markets and the economy face challenges along the way.
But investing through the current cycle will require careful considerations, as 2023 will likely be an unusual year. The recovery that may follow will likely be different than what we've had from other recessions because of high inflation, and the US Federal Reserve’s reactive interest rate hikes to counter it. Unfortunately, the economy will indeed be weaker well after the full effects of ongoing pressures are felt. However, the latter half of the year could be very different, with the Fed forced to change its tune yet again in the face of potential economic headwinds.
In our approach to 2023 and beyond, we highlight five observations from our Wealth Outlook 2023. The first two of these are – (1) markets lead economies, and (2) Putting your cash to work in a higher rate environment.
Starting with the former, many may not realize this but 2022 was the second worst year since 1931 in terms of combined stock and bond market performance. Much of it was down to the reversal of a dovish US monetary policy – instituted in the wake of the pandemic and subsequently reversed following high levels of inflation. The decline in equity markets that followed was largely in anticipation what may happen in 2023, which is the current period of economic weakness we are witnessing. But we also think that 2023 will presage a recovery in 2024. The second observation we have is putting your cash to work in a higher rate environment. At the yield levels that we are seeing today, bonds can be considered and potentially valuable to seek income and further diversification.
Our remaining three of five observations are that: (3) the US dollar may weaken; (4) inflation hurts every asset class; and (5) the value of long-term growth assets is being restored.
Starting with the US dollar, the currency is at high levels right now. That's driven up the value of US wealth in the world. But other currencies may become valuable over the next year or two because the relative value of the dollar – currently at its third peak over the last 50 years – will change. Its potential decline will allow investors to diversify portfolios outside the US and seek benefits from their appreciation (and the dollar’s depreciation).
Moving on to inflation, it may have hurt multiple asset classes, but we see it peaking in 2023 for the current cycle in the face of a possible downturn. Inflation is unlikely to return to pre-COVID levels in 2023 and we expect it to retreat to 3.5% and 2.5% by end-2023 and end-2024 respectively. This may allow investors to add exposure to long-term potential growth opportunities in our “Unstoppable Trends” themes such as Digitization, Greening the World and Longevity. And lastly, the whole process of the market going down in 2022 has created inherent value in a lot of assets with growth potential. Because as the market takes down all valuations, the most valuable ones coming out of those periods are ones with growth that exceeds expectations for the market as a whole.
If you consider a market entry point now, it is likely better than it was a year ago, particularly because during periods like the present we don't stop innovating. And while we seek creating the drivers of future returns, they do carry near-term lower valuations. However, such sentiments don’t imply that we're going to be instantly tactically bullish. Instead, we're taking a cautious and defensive market stance early on in 2023.
We do think that even in the first half of 2023, a lot can change, including, the equities market potentially adjusting a little bit worse before it gets better. For instance, the S&P 500 was down by just over 19% to December 29, 2022, but also had three substantial market rallies last year. Investors should note that we haven’t had a recession (yet), and historically a new bull market has never begun before a recession has even started. If that happens in the first half of 2023, we estimate that earnings will fall by about 10 to 12%, and at the moment the market is not fully pricing that. In terms of the extent of a potential downturn, there is obviously a war going on in the world.
But a lot of the things that would make the economy acutely vulnerable to a severe contraction are not in place, as was the case with the Global Financial Crisis in 2008-09. The recovery sequence we are looking for is the peaking of inflation, contraction in US corporate earnings, and unemployment turning negative, which in turn may cause the Fed to alter its hawkish course. Such a development, potentially at some point this year, will likely prompt the markets to focus on a potential recovery in 2024.
We're expecting a recession to take place in 2023, associated with a severe change in Fed policy. Therefore, the kinds of equities we want in portfolios would need to be companies with strong balance sheets and a history of raising dividends even through recessions, along with longer duration bonds.
The idea of dividend stocks, dividend growth and dividend reinvestment, is a fundamental strategy to consider incorporating in your portfolio to seek a positive rate of return. In line with this thinking, we are currently overweight preferred shares, global pharmaceuticals and cybersecurity. While in 2022, investors in non-US stocks saw both poor equity performance as well as declines in US dollar terms of nearly 10%, this year could see a reversal as the dollar slides. It is why we are overweight on Chinese equities.
We are also presently underweight on European and Japanese large cap equities and US small and medium sized stocks, which we believe will not come back later in 2023. When you go through a recession, areas like consumer discretionary, industrials, small caps, materials and financials have historically underperformed. Investing in these areas can wait for a turn in prevailing sentiment, when at some point in 2023 the Fed may change course and the markets look toward 2024. Additionally, investment-grade bond yields doubled in US dollar terms and that's an area investors may also consider. Depending on your current investment situation, consider adopting a defensive posture while staying fully invested according to your individual objectives.