First Quarter 2023 Review & Outlook

Looking back at 2022

2022, a year we are all happy to see the end of from an investment perspective. The worst year since 1937 for shares. The Bear Market (falling market) started early in the year and carried on through. Even a flight to ‘safer’ Bonds was not effective as, unusually, both bonds and equities lost value. They usually counteract each other.

There was no “wallop” event that caused the Bear Market but a consistent “drip, drip” of negative news that pushed investor sentiment ever and ever lower:

•Coming out of COVID, a high demand for goods\services but no supply led to Demand led inflation.
The Russia and Ukraine war limited Oil Gas and Wheat supplies, causing prices to rise – Supply led inflation.
Central banks persistently raised interest rates to curb inflation.
Bond prices fell as interest rate rises were introduced.
Equities fell due to uncertainty around a recession and pricing in the downturn.

World stock markets rallied in the 3rd quarter but this proved to be a false dawn. They have since rallied again in the last few months of 2022. The Morgan Stanley Companies Index (MSCI) (The world index) is shown below:

The key question is whether the 4th quarter (Q4) rally is another false dawn or the start of a Bull Market (Rising market)

Was Q4 the Turning Point?

There are a number of factors that lead us to conclude that Q4 was a turning point:

American Inflation has peaked, and Europe is following

Current UK forecasts see inflation reducing throughout 2023 from a high of over 10% to around 3% by the end of the year.

Central banks should moderate interest rate rises as they see inflation reducing. Current forward rates expect interest rates to start decreasing from August onwards

Economic forecasts are better than predictions:

Whilst there has been a slow down in the world economy, growth remains

China is coming out of lockdown.
Fears of the severity of a recession have subsided but are still mixed. The signs:

Implying recession are…	Implying no recession are…
The Leading Economic index (LEI)	Good levels of company dividends, buybacks margins and capital expenditure
A Yield Curve inversion	Low levels of consumer debt to total worth
US Service sector contraction	Job numbers of the employed are good
	Loan growth is strong, with low loan losses

On balance we believe Q4 was the start of a Bull market

Bear Market to Bull Market

We believe Q4 signaled the end of the Bear Market and the start of a Bull Market. History predicts, therefore, that 2023 should be a good year. The diagram below shows a history of Bear Markets since 1929. This shows Bull markets are longer and returns are greater than any losses from a Bear market:

Historically, the years that follow a Bear Market are postive. The diagram below records Bear market recoveries since 1942.

This shows that mostly returns are 38% in the year following a Bear Market and whilst the past is not an indicator of the future, on balance the past points to 2023 being a positive year.

Growth v Value stocks

A common categorisation of stock is between Value and Growth stocks:

Rising inflation means the future profits of Growth stock are worth less in real terms and hence their stock value has fallen more than Value stocks in recessionary times. The US market has more Growth stocks (Google, Microsoft, Tessla etc.) whereas UK market has more Value stocks. Hence the US market has underperformed the UK market in 2022.

The Long-term trend of markets

The Long-term trend of markets is up as shown by the diagram below

Crucially, the diagram also shows that volatility in the market has increased and that the market does not rise in a straight line. We expect, therefore, declines and corrections within an upward trend in 2023.

2023 Predictions

Our predictions for 2023, are therefore:

The peak of inflation has been reached and it will decrease in the year.
Early 2022 apoplectic forecasts did not materialise, and as known negatives are priced into the market, gradually investor sentiment will become more positive in 2023.
The slowdown of the world economy will be more modest than expected and any recession will be a soft recession already priced into stocks.
Bonds and shares should recover. Both Growth and Value stocks will do well in 2023, but the bounce back of Growth stocks will be greater.

But our Worry List

The real worry is the unknown, but it cannot be planned for. We remain vigilant for these. Known worries that we are monitoring are:

Inflation does not decrease, and Central Banks continue to increase interest rates
The US economy slowing and sliding into a deep recession.
The unlocking of China leading to another Chinese lock down.
An escalation of the Russia\Ukraine war beyond the region
A second conflict, (maybe China and Taiwan, India and Pakistan)