2022 was one of the occasional years where financial market news becomes front page news, with rising interest rates, rampant inflation, the strength of the US$, collapsing crypto-currencies and the sell-off in the technology sector all reaching the wider consciousness. Despite this turbulent background and the harrowing events in Ukraine, equity markets generally proved relatively resilient, particularly for euro-based investors, where percentage losses for the major indices were typically in the low teens. The Irish market was an underperformer, with strength in the domestic banks being more than offset by losses at stocks more sensitive to the global economy, such as Kingspan and Smurfit Kappa. Conversely the UK, despite ending the year on its third Prime Minister, was amongst the best performing global markets, boosted by a heavy weighting in energy and healthcare stocks, both of which were in favour with investors.
Much of the drama was played out in the bond markets, as the era of minimal or even negative interest rates, that had been in place since the 2008 financial crisis, ended abruptly. Having begun the year at 1.5%, the key US 10-year Treasury bond yield ratcheted higher as the Federal Reserve aggressively raised interest rates, peaking at over 4% in October. It has since retreated slightly to end the year around 3.8%, on growing evidence that inflationary pressures in the US and elsewhere have peaked, as key commodities including oil and foodstuffs such as corn and wheat give up some of their gains. In a similar vein, the US$ which was trading at multi-decade highs against a basket of currencies including the euro, where it went through parity, in the Autumn, has also weakened somewhat, although it remains at elevated levels compared to the beginning of 2022.
The debate around the market outlook for 2023 is transitioning from inflation to growth, specifically whether the US, EU and other major economies are entering a significant recession, which would have negative implications for corporate earnings. Bloomberg Economics forecasts global GDP growth of 2.3% in 2023, down from 3.2% in 2022, and the third lowest after 2009 and 2020 since 1993. Whilst the labour market remains strong in the US, the world’s largest economy, as evidenced by December’s non-farm payroll figures, the bond market is predicting a sharp recession. This reflected in the inverted yield curve, with the yield on short-dated two-year US Treasuries significantly higher than that of 10-year treasuries. Normally the reverse holds true, reflecting expectations for economic growth, but the current inversion is the highest since the early 1980s and is cited as evidence the US will enter recession in 2023.
The rally in equity markets in Q4 has left valuations back at levels that are not pricing in any material downturn in earnings. This is particularly true in the US, where the forward multiple of 17X, which is based on predicted 4% earnings growth in 2023, is not particularly cheap by historical standards. In Europe, equity valuations are more supportive, on a forward multiple of 12X, however the ECB have been slower to tighten monetary policy and the economic fallout of the energy crisis from the war in Ukraine looks set to exert a greater economic impact. Sentiment has been improving towards Asian markets, as China eases its strict lockdown policy in the face of protests. Sectors which would benefit from this reopening such as luxury goods and resources are currently performing strongly.
Bulls will also point to supportive seasonal factors, such as the third year of a US Presidential term typically being supportive for risk assets. Of greater significance is likely to be expectations as the year progresses for a peak in US interest rates as inflation continues to fall, potentially even leading to a cut in the second half of 2023 by the Federal Reserve. This should positively impact sentiment towards risk assets, notably equities, as earnings forecast for 2024 could be revised upwards against a more accommodative interest rate environment. Other catalysts for sustained equity market gains could include a peace deal in Ukraine, a shallow global recession and corporate earnings proving resilient. To borrow a sporting analogy, with the FIFA World Cup having concluded in Qatar, many strategists are expecting 2023 to be a year of two halves, with risk assets coming under pressure in H1, before rallying in the latter half of the year.
Turning to sectors, we do identify value in Energy stocks, where forward multiples are at extremely depressed levels, typically single-digit PEs, with attractive dividend yields and the potential for further share buybacks. Even in the event of further $15-$20 pullback in the oil price, our favoured names such as TotalEnergies would continue to generate significant free cashflow, which is also being invested in the transformation to sustainable energy. TotalEnergies is one of the energy majors most advanced in terms of transitioning to a post-carbon fuel world and we do not feel this is reflected in the share price. The technology sector has been amongst the worst performers in 2022, reversing the multi-year trend of outperformance. Whilst many of the names which sold off heaviest were concept stocks with little in the way of revenues or profits, some more indiscriminate selling seems to offer an opportunity in the likes of Alphabet, the owner of Google and YouTube, which now trades on a significant discount to its five-year average forward PE multiple. Closer to home, Ryanair appears well-paced to benefit from continued demand for leisure travel and has proven historically it can trade well through a recession as consumers trade down to the lowest cost operator.
Predicting the calendar year ahead is often an exercise in futility and 2023 will likely be no different. We have however tried to identify some themes and frameworks above around which investment decisions can be made going into the new year. Good luck!