THE first six months of 2023 has thrown up plenty of surprises for investors, from the impressive performance of equity markets to China’s lacklustre recovery after its reopening. However, many things still remain unclear as the midpoint of the year arrives. For instance, the critical question of whether the global economy is headed for a recession is still up in the air, as is the persistence of high inflation.
Chief Investment Officer of UOB Private Bank Neo Teng Hwee shares his insights on the issues at the top of investors’ minds for the second half of 2023. He suggests that recession and continued inflation are not on the cards this year, while recovery of the world's second largest economy is a work in progress.
Here, Neo answers pertinent questions investors may have.
Q: Will there be a recession this year?
A: There's been a lot of talk about a potential recession, but markets have been doing well. While an inverted yield curve often indicate an impending recession, rising stock markets contradicts this notion. I think this unusual situation will persist for some time across many markets.
Historically, the market cycle tells us that inflation leads to rate shocks, which cause bear markets, and in turn cause recessions. Recessions then lead to rate cuts, ushering in the next bull market. That’s been the trend for the past 50 years.
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However, despite experiencing bearish market conditions in 2022, we have not seen a recession. The cycle has been disrupted. We've had unprecedented tightening by the Federal Reserve System (Fed), several regional banking crises and the failure of a very large Swiss bank; yet economies around the world have navigated this set of challenges very effectively.
We don't see a recession this year, simply because it's hard to see a recession when the job market is so strong. Even if we do see a slowdown, we anticipate a relatively soft landing. The recession is more likely to be a risk in 2024.
Q: What is your view on where inflation is headed?
A: I believe that inflation has peaked for this cycle, although many may disagree because everything feels so expensive now. But when we think about inflation in financial markets, we are looking at year-over-year change, and US inflation peaked at 9 per cent in June of 2022.
However, the inflation decline had little to do with the Fed’s tightening, as the Federal Funds Rate was only 1 per cent in June 2022. A large part of the inflation surge was supply related, and there were also plenty of transitory elements. So, the inflation number is likely to trend lower due to base effects, with some easing expected in components such as rentals and shelter.
Q: What are your thoughts on the employment situation?
A: Historically, when job openings come down, the unemployment rate goes up. But this time around, job openings have started to reduce while the unemployment rate stayed at a very low level. In this context, there appears to be a pathway for the labour market to cool without the Fed having to crash-land the economy. I believe that the pandemic and its consequences have distorted the data.
Companies are also starting to announce layoffs, and in our view, wages are likely to ease as well. As such, some of the concerns that the Fed has on tight labour markets and wages exerting pressure on inflation will be less of an issue going forward in my view.
Q: After the 20 per cent sell-off in equities last year, do you think the bear market is over?
A: The bear market last year doesn’t appear to be over as history suggests that bear markets bottom towards the end of a recession. However, some sectors such as tech could have already gone through their bear market phase and are making a strong comeback this year. A lot of that has to do with the potential of generative artificial intelligence (AI) like ChatGPT.
We should think of AI not as a technology, but a general purpose tool that can have a transformative impact on many industries for years to come. The main impact for companies will be cost savings, as it can augment many types of work. For certain companies it will also be a source of revenue. But this means that those who fail to embrace AI will risk being left behind.
The downside of AI’s rise is job displacement, as automation replaces more roles. This could lead to an environment that is less favourable for companies and might eventually involve higher taxation that could wipe out any gains derived from the technology.
Despite the tech sector’s strong showing, however, I don’t believe that a bubble is forming, as the current valuations are far lower than it was during the last tech bubble in 2000. Besides tech, the healthcare sector is another industry that has been showing growth and offers investors a hedge against recession.
Q: What is your view on China’s growth prospects following its reopening earlier this year?
A: China has been a disappointment. We expected the reopening trade to have a lot more traction, but we see that the economy has lost momentum. That said, China has the opportunity to be one of the best trades because the economy has a lot of slack and asset prices are trading at recessionary valuations. The problem is that the government is overly cautious about reflating the economy and creating a debt bubble. This may result in a situation where any stimulus may come either too little or too late.
With increased regulatory scrutiny and the ongoing Sino-US geopolitical tensions, the private sector in China is also less willing to invest. So, if the private sector is not investing, the government has to come in and make up for it, but that’s not happening yet. China will have to decide whether it wants to prioritise growth or things like common prosperity and other social objectives.
Q: In summary, what should investors look out for in the second half of 2023?
A: Beyond just looking at market averages, investors should focus on widening divergences. So, focus on large caps over small caps, growth stocks over value stocks, technology versus cyclicals. For China, we believe it is better to get exposure through proxies such as European luxury, which is actually a China play, and specific sectors that will benefit from current policies. We do expect some sort of government response to the worsening economy and markets could stay supported in the short-term.
To hedge against macro uncertainties, such as the risk of recession, invest in healthcare, investment-grade bonds and alternative investments. Finally, we believe there will be an earnings soft landing, so seek out multi-asset portfolios as a core and use strategies to maximise returns in a range trading environment.
Disclaimer:
The material contained in this publication is intended for information only and does not constitute investment recommendation or advice as it does not take into account personal investment objectives, specific investment goals or financial situation. UOB does not accept any responsibility for any loss or damage caused by any use of or reliance on the opinions or views expressed in this publication which may be subject to change due to dynamic market conditions.
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