Paul Flood is Head of Mixed Assets at Newton Investment Management. Here he reflects on the challenging markets of 2022 and looks ahead to 2023 and what he hopes will be a “more rationalised, normalised world”. Only time will tell but let’s hope he’s right!
“2022 has been a topsy turvy year to say the least – bond markets had one of their worst years on record at the same time as a fairly brutal sell-off in global equity markets. Looking forward to 2023, we see bonds as offering a more robust place in portfolios. Whilst there will be many risks for investors to navigate, we do believe that a diversified portfolio is likely to perform better next year than it has done over the past twelve months. In many respects, the declining diversification benefits of bonds will have likely looked obvious in hindsight given the historically low yields, the risks of which we have been highlighting for many years.
“Central banks for the last decade have kept rates at the zero bound, but this is unlikely to be the case next year as concerns about elevated levels of inflation currently trumps desire for economic growth for the first time since the great financial crisis in 2008.
“There are a number of fundamental shifts in policy that make it more likely that we will see higher inflation levels and more volatile inflation in the future than we have witnessed in the past two decades. One of these is the move towards deglobalisation and onshoring resulting in the west bringing back jobs and manufacturing lines back to western economies. This is likely to, at best, to lead to a reduction in the deflationary costs associated with globalisation that we have benefited from over the last two decades.
“Secondly, we are about to witness one of the largest infrastructure spending sprees in a generation as we look to decarbonise our power generation and electrify our transportation systems. This will put significant pressure on commodities associated with the build out of the green transition and increased demand for commodities such as copper, nickel, cobalt and lithium amongst others, as well as being quite energy intensive to build out.
“Central banks, particularly the US federal reserve, appear determined to ensure inflation does not get out of control, so it is unlikely that we will continue to see the recent high levels of inflation. If this is the case, then it is difficult to see how bond markets could have another year as bad as what we have just seen, but would advocate a higher allocation to real assets, which benefit from more elevated levels of inflation as a good diversifier.
“With central banks being more focussed on keeping prices down and what looks to be a more inflationary backdrop, we are likely to see a lot more action from central banks than we have over the last decade. More frequent central bank policy adjustments as well as balance sheet reduction (quantitative tightening), as policy makers look to unwind the enormous bond portfolios they have built up through quantitative easing, may lead to higher volatility and shorter business cycles than we have become accustomed to. This will result in more frequent changes in market direction and more opportunities for flexible and dynamic investors that are able to adapt and navigate the changing tides.
“The outlook for equity markets in 2023 looks very different than the one we have witnessed over the last decade, and we expect a change in leadership to favour end markets which benefit from the increased spending on the build out of low carbon technologies such as renewables, grid investment and energy efficiency. For investors, this also means being more active as beneficiaries of this structural growth opportunity are likely to be industrial and automation companies which, unlike the technology bull market of the last decade, are more cyclical in nature.
“If 2022 was the beginnings of a change in regime, and forewarning of what lies ahead, then we welcome it, a market that offers more opportunity for active managers to excel. We see far more rational valuations today than the elevated valuations and paltry returns on offer in more recent times. In 2023, we are likely to see better opportunities to add value as an active investor and look forward to investing in a more rational, normalised world.
