We’ve cut our global growth forecast for 2023 from 2.7% to 1.7%. This is roughly half the long-term trend. The stall in the world economy should leave interest rates peaking and inflation on a decelerating path into 2024.
We see the US economy growing just 0.7% in 2023 before rebounding to a 2.0% growth rate in 2024. We also expect S&P 500 EPS to fall 9.7% in 2023 after a 6.4% gain this year (+4.5% in 2024).
Investor worries have been premature and positioning bearish, setting the stage for the present rebound in risk assets. The strongly telegraphed central bank moves set markets on a path of forecasting recession in 1H 2022. Various indicators don’t suggest a disastrous economic collapse. Nonetheless, it is also premature to price in a recovery when the slowdown has yet to significantly unfold.
Recessions have always had a component of
shock amid overconfidence. Widespread market fears suggest this dynamic (which worsens the outcomes) is lacking.
Nonetheless, we see US labor markets swinging to small net job losses in 2023. The semantics of what constitutes recession shouldn’t be the primary concern of investors, but we see the outlook divided between 50% recession (mild or deep), 40% slow growth, and a 10% probability of a stronger recovery.
The possibility remains that the US economy
comes to grips without contraction.This is predicated on falling inflation in the period just ahead when labor markets are still improving. It would require a speedy recognition by the Fed that it doesn’t need to push the economy into collapse. Conditions in Europe and the UK, meanwhile, seem too far gone to avoid a contraction. We expect these regions to see real GDP declines of 0.5% and 1.0%, respectively, in 2023.
pivot from the Fed, we see significant risk of an early end to the post-COVID economic expansion. We’ve made additional asset allocation changes to reflect this. On the Fed’s hawkish guidance, the US Treasury 2-year note now yields 3.2%, more than any other US Treasury. Short-duration US Treasury yields are now nearly as high as 30-year Italian or Greek debt yields.
With some very-low-risk, short-duration bonds now yielding close to 4%, we’ve added 2% to these holdings. We continue to overweight intermediate IG corporate bonds and long-term US Treasuries as a risk hedge. We believe US 10-year Treasury yields could temporarily fall back to 2% on signs of economic contraction sometime in 2023.
To fund the increase in US bonds, we’ve eliminated the overweight to global natural resources equities. This reduces our global equity weighting to -2% from neutral. This weighting is now the same with- or without commodities.
On average over the last four recessions, the Energy and Materials sectors (combined) posted an average peak-to-trough EPS decline of 86%.While we see attractive dividends across the industry and a valuable hedge against supply shocks, our risk posture no longer favors an overweight. We would prefer to maintain opportunistic overweight positions in narrow industry groups such as LNG and EV materials rather than petroleum.
Like the broader world, we have cut China’s growth outlook for 2023 and see a below consensus 4% growth rate in 2024. Nonetheless, the contrast between the US and China is growing, with China’s economy likely to benefit from a new easing cycle while the Fed continues to tighten. We remain slightly overweight both equity markets within a global underweight. We are more defensively positioned in US equities through large cap dividend growers, pharmaceuticals and cyber security themes while underweight small caps.