Key investment themes for 2023: the hangover


There are many non-market-related highlights to look forward to in 2023: The men’s rugby and cricket world cup tournaments, superhero movies, new fashion trends, unexplored destinations, and fresh developments in self-care habits that can further change how we live and work.

But first, we have to try to get 2022 behind us. Unfortunately, like a hangover from a New Year’s Eve bender – the ones that end in tears – we’ll be waking up in 2023 with all the financial headaches we couldn’t shake off. 

Worries about inflation, interest-rate hikes, the war in Ukraine, China’s economic shutdown to fight Covid, supply chain logjams, questions around equity valuations, and then, of course, the crime, load-shedding, potholes, dry taps, and the ruling party in chaos here at home.

A last-gasp rally in international stock and fixed-income markets that started in October failed to stem losses suffered for most of the year. South African markets take their cues from what’s happening globally, so here are themes to watch out for in 2023:

1.     Moribund economies to hit earnings

The outlook for the global economy is growing gloomier by the day, dimming the prospects for companies to boost earnings and for consumers who are already struggling to cope with rising costs of everything from food to fuel. 

The International Monetary Fund, after saying in October that 2023 will feel like a recession, a month later warned that economic indicators are weakening, pointing to further challenges ahead. That’s starting to show in analyst earnings estimates.

For the first time since at least 1999, the average forecast of Wall Street strategists predicts a decline in the S&P 500 Index next year, according to a survey of 17 firms by Bloomberg. The analysts were divided, with calls ranging from a 10% gain to a 17% decline – the widest dispersion since 2009.

Goldman Sachs is warning that the bear market in stocks will intensify in 2023, with higher volatility, before it gets better. Morgan Stanley predicts a volatile path for US stocks: shares are too expensive and earnings from American companies will drop. According to the US bank, the second half might look slightly better for the market.

For investors, this means that picking winners and losers becomes harder, or where to find avenues to make money becomes even more confusing. Now that the era of cheap money is over, investors can no longer park their cash in an exchange-traded fund or an index and expect it to grow. It needs active management – and nowadays – not even just stocks or bonds will cut it.

Considering that stocks on the S&P are trading within 20% of their all-time highs, valuations are at multiples of where they were a few years ago (when bull markets were running hard), inflation is still uncertain, no one knows when the Fed is going to pause, economies are slowing, and consumers are struggling then it seems only fitting to say there’s an accident waiting to happen.

2.     Using alternative assets to generate returns

Some investments thrive in uncertainty and volatility, chief among which are hedge funds. These alternative investment strategies have long lost their reputation of being run by cowboys, who take risky bets, charge excessive fees and don’t perform as well as promised. This is not true. 

In April 2015, South Africa became the first country to implement comprehensive regulation for hedge fund products. Fees are negotiable and, in many cases, depend on performance.     

Hedge fund managers have more flexibility to take short or long positions in securities (bets that assets can fall or gain) or market-neutral funds (which seek to make above-average returns despite market conditions – often using products, such as derivatives that derive their value from an underlying asset like commodities, currencies, equities or interest rates). Macro hedge funds attempt to profit from broad swigs in indexes caused by major political or economic events.

Assets under management in South Africa’s hedge fund industry soared 20% to R104.54 billion in the six months through June. According to a report in Institutional Investor, hedge funds outperformed the market in the first half of 2022, with an index compiled by Hedge Fund Research falling only 5.9% compared with a 20% drop in the S&P.

3.     Inflation – get used to it

Where’s the next stop for inflation? And when will central banks decide that they’ve done enough and step off the platform of increasing rates? The Federal Reserve and the European Central Bank were wrong when they last year said that inflation would be temporary. 

Now the world’s most influential central banks are caught in aggressive hiking cycles, the effects of which ripple across the globe, including in South Africa, where the Reserve Bank has followed the size of the US rate increases. 

There’s no telling when inflation, which earlier this year hit 40-year highs in the US and UK and soared in double-digits in the euro area, will peak. Morgan Stanley expects global inflation to reach its pinnacle in the fourth quarter of next year. The Fed could hike its main target range to 4.5%-4.75% by January from 3.75%-4% and keep rates there for 2023. 

J.P. Morgan Asset Management predicts prices will rise more slowly in the US, although volatility in commodity markets and other supply chain risks could pressure the Fed to act. It sees rates at 5% in 2023, with upside risk. 

Digging deeper into the inflation data reveals that price gains across the US are broad-based. European Central Bank President Christine Lagarde has warned that inflation there hasn’t yet peaked, mainly because high energy costs must still feed into the rest of the economy. 

Our central bank, which hiked rates to a five-year high in October, hasn’t shown signs of easing, forecasting that inflation will only slow to about 4.5% in 2024.

Again, this means investing smarter and using financial instruments to achieve above-inflation returns when markets are trading flat or falling.

4.     The aftermath of crypto’s crash

The collapse of FTX, a cryptocurrency exchange once worth $32 billion, and its fallout echo the 2000 dot-com bubble. When the bubble pops, you see weird things come out of the woodwork. 

We’ve had years and years of cheap capital that was freely available. Companies were raising funds at extreme valuations – yet have never been profitable. There’s been much speculation in all sorts of investments and asset classes.

What has been troubling is that some of the largest investment firms have invested in FTX, most of which have lost money. The market value of crypto assets peaked at $3 trillion last year. The US is now seeking to oversee the industry and set some ground rules; otherwise, it could pose risks to the financial system, albeit indirectly via private funds, which could see a liquidity squeeze.

This industry still has a way to go, and there are many risks that the market isn’t fully pricing in yet.

5.     No escaping energy in sustainable investing

While sustainable investing is coming under heat, it isn’t going away. The need to redirect capital to protect our planet, keep our leaders on their toes and support a better future is just too overwhelming. 

Environmental, social and governance investing has been criticised because of product mislabelling and the inconsistency with rating agencies, independent scoring firms or asset managers evaluating investments. These factors must be included in the screening process because most investors demand them. You have to be alert to which investment targets could be “greenwashing” their ESG process by having the right processes in place.

One over-arching topic that will dominate this space is the push toward renewable energy. McKinsey & Co. estimates that by 2026, global renewable-electricity capacity will rise more than 80% from 2020 levels, mainly wind and solar. 

Russia’s invasion of Ukraine highlighted Europe’s dependence on Moscow for its energy needs. In South Africa, we know the challenges of load shedding; hopefully, someone will turn the lights on. 

Jacobus Brink, the head of Investments at Novare Investments.

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