SUMMARY
In 2022, investors believed the US would be the most resilient economy in the face of war-driven supply disruptions. However, recent data suggest the Fed’s contractionary monetary policy is hitting home.
We’ve slightly raised global GDP forecasts for 2023 despite a downgrade to our US growth outlook. This is driven by China’s earlier-than-expected move to end its COVID zero policy and strong signs that Europe’s energy shock is abating. We’ve raised the 2023 global real GDP estimate to +2.0% from +1.7%. This is on an expected 5.5% rebound in China’s growth this year, and the EU pulling out of a near-term contraction.
Despite a strong headline GDP gain in the final quarter of 2022, we have cut the full-year 2023 estimate of US real GDP to +0.5% from +0.7%. Sharp gains in consumer goods and home inventories in the past year have left construction, trade and industrial production falling. Leading indicators suggest these declines will deepen.
We believe the January employment report is likely to be the last above-trend gain, perhaps with a 200,000 rise. Large seasonal swings in employment in January may distort the numerous signs that labor demand is abating. We would expect labor market data to weaken sharply into the spring.
While downshifting to 25-basis-point rate hikes, Fed Chairman Powell is likely to deliver a hawkish message at his February 1 press conference, focusing on the inflation performance of the last 12 months rather than leading indicators of future progress. The Fed will ignore much of the slowing in headline inflation until US employment falls. Meanwhile, US broad money supply (M2) is contracting, a strong predictor of the pace of inflation with a two-year lead time.
Selling and reinvesting our overweight in gold
We have eliminated our overweight in gold for now, given the sharp rise in real bond yields over the past year. Gold has risen 5% in US dollar terms in the last two months while Global Fixed Income lost 10% and Global Equities -7%. Outperforming cash despite its zero yield, gold has been the only significant store of value that did not correct lower in the face of sharp monetary tightening. While we don’t believe gold is at risk of a sharp correction, as inflation slows, rising real yields can weigh it down.
We’ve reinvested the proceeds of our tactical gold position in both global stocks and bonds after the largest loss for combined stock/bond portfolios since 1931. We’ve reallocated our position between short-term US Treasuries yielding 4.25% and non-US developed market equities.
Large cap EU and Japan equities can be a vehicle to deliver positive returns in US dollars if regional currencies appreciate after the energy shock of 2022 and excessively hawkish expectations for the Fed. Our reallocation to a less US-focused one is unlikely to be the last. Apart from our ongoing China overweight, our actions partially close underweights we had kept out of caution due to the war in Ukraine.
We’ve slightly upgraded our economic views for the EU, UK and Japan. These regional equity markets have meagre 2023 EPS growth expectations compared to the US and trade at less than 13X expected earnings vs 18X for the US. While having stronger long-term growth prospects, we believe the US faces larger risks of downward earnings estimate revisions in the coming few quarters.
We believe all global equity markets face near-term risks as the Fed will likely to deliver a hawkish message until unemployment rises decisively. We focus on investment grade assets with high quality income generating potential. Nonetheless, we would expect to allocate more to global equities generally when incipient economic weakness in the US is more fully discounted and preconditions arise for a future economic recovery. We see our enlarged bond overweight as a potential future funding source.
