The new year started with the same trends that appeared around mid-October last year. That is a weaker U.S. dollar, lower than anticipated U.S. inflation, and lower U.S. yields. Since mid-October, developed market equities have rallied the most, followed by emerging market equities (especially Chinese equities) –a significant portion of the recent move has come from currency moves in the euro and Japanese yen. China’s re-opening was a surprise, as the country moved away from its covid-zero policy, profoundly affecting Chinese equities in a very short period. In addition, the winter has been unusually warm, especially in Europe, improving the continent’s energy outlook (the Davos 2023 World Economic Forum started this week with not much snow on the ground).
Finally, inflation in the U.S. has come in lower than expected, leading to a decline in the U.S. dollar versus European and Asian currencies. While the U.S., already experienced a technical recession in 2022, with Q1 and Q2 growth rates in negative territory, the slowdown in growth did not affect the strong positive momentum in employment, personal income, personal spending, or industrial production. The U.S. economy has the potential to achieve a similar outcome in 2023, where slowing economic activity does not turn into an outright recession with the help of a strong labor market and strong U.S. consumer activity.
Even with milder weather, a relatively hawkish European Central Bank, and inflation that is trending lower, we still expect that the uncertainties could tip European economies into recession.
Therefore, we remain underweight the international developed markets.
In China, the swift U-turn of the zero-COVID policy could save economic growth during the second half of 2023. However, the lifted restrictions could mean that millions of people are expected to get COVID with unpredictable consequences.
We also remain underweight emerging markets assets. There is promising momentum in Emerging Market equities and especially in bonds with the help of a weaker U.S. dollar and optimism initiated with China’s reopening. Consensus assumes that China could deliver 4.8% growth rates in 2023 with the help of reopening efforts. We assume much lower growth rates unless China unleashes fiscal and monetary stimulus at the National People’s Congress in March.
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