Fifteen Imponderables for 2023
Fifteen reasons that we have lower conviction than ever on the market outlook for 2023, with a H1 equity market rally as the path of least resistance
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This Insight is an extract adapted from the Panah Fund letter to investors for Q4 2022.1
Among the sell-side ‘year ahead’ strategy pieces published in late 2022, there was an overwhelming consensus on the expected path of markets in 2023… Equities would continue to plunge during Q1 2023 on ongoing recession worries and monetary tightening, but would then recover during the second half of the year as central banks started to ease policy.
Although this outlook seems plausible, we guess that it is unlikely to play out. Whenever the consensus leans very strongly in one direction, the markets have a habit of doing something completely different.
Just how reality might actually differ from this sell-side consensus scenario is much more difficult to predict. Rather than spending time imagining a single ‘base case’ scenario, however, we usually find it more helpful to entertain a number of possible trajectories for markets. We are then able to monitor which one of these trajectories best matches reality as it unfolds.
This year, we have even lower confidence than usual in any particular outcome. This is because the crosscurrents and variables would appear to be among the most complex faced by investors in many years. Relevant imponderables include the following:
China may well have suddenly reopened from ‘Zero Covid’, but will the domestic consumption bounce-back be strong enough to offset headwinds from a slowdown in global export demand? Most importantly, will the real estate market stage a strong recovery or will there be lasting damage from the multi-year tightening campaign?
Will China allow outbound tourist numbers to surge back to pre-Covid levels,2 or will the authorities seek to restrict outbound tourism and trap liquidity onshore to help support domestic consumption (and in particular the beleaguered real estate market)?
Does China’s sudden reversal on ‘Zero Covid’ and reopening herald the dawn of more pragmatic, ‘open’ policymaking from the authorities, or is this merely the latest example of arbitrary decision-making3 from an increasingly autocratic leader who is entering a second decade in office with few checks on his power?
In Vietnam, will the ongoing anti-corruption crackdown, which has recently culminated in the unprecedented removal of the country’s president, continue in 2023? If so, will it start to affect the country’s growth prospects and further delay vital equity market reforms?
Even though US inflation has rolled over and seems set to fall sharply in the coming months, might inflation rebound sharply during the next upcycle? Will inflation in the 2020s run at a higher average level (and with increased volatility) compared to last decade?
Will the Federal Reserve (the ‘Fed’) insist on maintaining policy rates at elevated levels in 2023 to bring on a recession and kill inflation expectations completely, or will the central bankers be willing to cut rates as the markets hope and expect?
Will US earnings roll over in 2023 as the economy slips towards recession, or will earnings remain resilient, allowing equity markets to make a ‘soft landing’?
Will the debt ceiling debate in the US prove to be just another chance for politicians to grandstand with no major adverse consequences, or will the unthinkable happen (i.e., a technical default) if no deal to raise the debt ceiling is reached by early June?4
Will energy prices fall into a developed market economic slowdown in 2023, or will a combination of Chinese reopening demand and oil supply-side issues (i.e., multi-year underinvestment and OPEC+ constraints) mean that energy prices remain well-supported during any downturn, and then move sharply higher in any subsequent economic recovery?
Will the terrible war in Ukraine grind on indefinitely, or can some sort of settlement be reached in 2023, perhaps after a Spring Offensive? If any settlement can be reached, would this involve any relaxation of sanctions on Russia and ‘normalisation’ of commodity trade flows?
Despite the massive surge in developed market interest rates in 2022, so far there has been a surprising absence of global systemic financial risk events. Is the global economic system really more resilient, or is it merely a matter of time before another financial crisis emerges (perhaps as the bubble in ‘private investment’ deflates, adversely affecting pension and insurance companies, or perhaps a serious sovereign debt crisis)?
The Bank of Japan’s commencement of tightening has so far gone smoothly (even if it has meant the central bank has had to make record JGB purchases to cap yields). Can the calm last, or will investors ‘gang up’ to exert more pressure on the central bank to normalise monetary policy more rapidly? As interest rates rise for the Japanese Yen, the last great global funding currency, might this catalyse unexpected stress in other corners of financial markets?
Figure 3: How much longer will the Bank of Japan be able to fight off the bond vigilantes to defend its controversial ‘Yield Curve Control’ policy? (Source: Kuniyoshi via Fujiarts)
Did Asian equity markets already hit bottom for this cycle in October 2022? Even if global markets do weaken in 2023, might Asian stocks be able to hold last year’s lows, even as the US and other developed markets derate further?
Given the increasing ‘weaponisation’ of the US Dollar through sanctions, how quickly will other countries seek out alternative stores of value for their forex reserves (i.e., gold)? Might the forthcoming rapid rollout of CBDCs around the world undermine US Dollar dominance faster than expected?
As the traditional sovereign buyers of US Dollar debt incrementally allocate to alternative ‘stores of value’, will the Fed be forced to back away from Quantitative Tightening (‘QT’) and instead reinstate Quantitative Easing (‘QE’) in late 2023 or 2024 in order to place a floor under bond prices (i.e., Yield Curve Control)?
We do not have definitive answers to any of these questions. We do, however, think carefully about the potential impact to the portfolio in various different scenarios, and will be ready to act as events unfold.
That said, if someone were to place a gun to our heads and force us to choose the ‘most likely’ path for markets to follow in 2023, we would tentatively reply that we think there is a window for asset markets to perform well early in the year. This would be as US inflation falls, markets anticipate Fed easing on top of a technical boost to liquidity,5 China reopens, and as investors scramble to catch up after becoming too bearish in late 2022.
The second half of 2023 then might become more challenging as growth slows, especially if markets are by mid-year already discounting a rosy future. If inflation were to rebound in H2 2023 and remain sticky, this would be even more troublesome as it would present the Fed with a dilemma as to whether to prioritise inflation-fighting or employment.
Although our levels of conviction are not high, our tentative 2023 scenario is worth considering, if only because it might cause the maximum amount of pain to investors who have been expecting the opposite. Sell in May?
As always, the most important question for Panah is not to second-guess market movements. Rather, we are more interested in finding more idiosyncratic investment opportunities with favourable risk-reward, to drive attractive risk-adjusted returns for our investors over the long-run.
Thank you for reading.
Andrew Limond
The original source material has been edited for spelling, punctuation, grammar and clarity. Photographs, illustrations, diagrams and references have been updated to ensure relevance. Copies of the original quarterly letter source material are available to investors on request.
Pre-Covid, China’s outbound tourism was responsible for a negative impact to the current account in the order of ~3% of GDP, helping to push the current account balance towards deficit.
The recent ‘Zero Covid’ reversal appears to be yet another example of arbitrary policy decisions in recent years, joining the ranks of: P2P finance suppression, the tech crackdown, the private education meltdown, real estate restrictions, and ‘Zero Covid’ lockdown debacle. China used to be run in a more competent, technocratic fashion, but is this no longer the case?
5 June 2023 is the estimated date that the Treasury’s extraordinary ‘debt ceiling’ measures are due to be exhausted.
There should be a liquidity boost as the ‘debt ceiling’ drawdown from the Treasury General Account offsets QT.
