The Economy And Markets
Brian Nick, Chief Investment Strategist

Key Points To Know
• Inflation should finally decline. Global inflation remains very high heading into 2023, but we see signs it has peaked. As consumer spending growth normalizes and the goods/services balance is restored, corporate profit margins will likely compress. At the same time, global real estate and labor markets are showing signs of returning to balance, reducing upward pressure on rent and wages, both key drivers of inflation. Energy costs remain a wild card with geopolitical risk influencing oil and gas prices, but even a plateau at current levels would provide a meaningful drag on global headline inflation over the next few quarters. Countries where central banks have already layered in substantial policy tightening appear to be ahead of the game in bringing down inflation (Figure 2).

• But economic growth will slow, too. Consumer spending is keeping the developed world growing, with many countries still benefiting from pandemic-era pent-up demand and excess savings. Jobs have returned quickly and wages are rising about as fast as prices. Yet consumers have almost never reported feeling so down in the dumps. Sentiment surveys are registering lower readings today than even in the midst of the 2008 financial crisis. But while consumers aren’t talking the talk, they are walking the walk: growing their spending well in excess of inflation (Figure 2). Rising net worth and job security are far more important predictors of consumer behavior than comments people are willing to share with survey takers.

• We expect varying resistance to recession across countries. 2022 pitted the irresistible force of higher rates against the immovable objects of consumer spending and hiring demand. For countries to stay out of recession in 2023 — or keep those recessions mild when they occur — it will take a combination of carefully calibrated monetary policy and increased use of consumer balance sheets (i.e., reduced savings and increased credit). Job security will become the key variable to watch for consumer strength. Consumers save less and spend more when they feel confident in their employment prospects. While unemployment rates remain low around the world, the “immovable objects” will likely start to budge sooner in Europe and emerging markets than they will in the U.S.

• Policy risks aren’t going anywhere. Ask most investors, and they’ll tell you that inflation was the single largest obstacle to generating positive returns in 2022. But that’s not quite right: It was actually central banks’ collective response to that inflation that sank diversified portfolios. Higher discount rates took down equity valuations — though not profits just yet — and led to substantial losses on most categories of fixed income. The risk that rates go even higher as central banks struggle to fully break inflation may keep markets on edge. And even if policymakers sound the all clear on further rate hikes, the environment that follows is likely to feature either higher rates for a prolonged period (our base case), or a dramatic rally in government bond markets driven by a severe macroeconomic downturn (our primary downside risk case). Neither of these scenarios promises a smooth melt up for diversified portfolio balances in 2023.

GIC Asset Class Outlooks

Equities
Saira Malik, CIO

Best Ideas
• Our highest-conviction investment idea continues to be dividend-growers, which tend to be high quality companies with strong free cash flow levels. This area also offers solid income and tends to be less susceptible to volatility.

Investment positioning
• The bad news as we enter 2023: We expect the all-too-familiar headwinds of 2022 (persistent inflation, rising yields, hawkish central banks and a rocky geopolitical landscape) to drive volatility and uncertainty through the start of next year. We should continue to see pockets of strength across global equity markets on specific catalysts such as perceived dovish messaging from central banks or even a moderation of rate hikes, but the risks surrounding earnings, employment and contractionary manufacturing data lead us to believe we’re not yet out of the equity bear market.

• As a possible bright spot, we believe inflation is moderating, which should provide some tailwinds for stocks in 2023. In particular, we favor dividend-growers, an area where relatively higher income can help offset price return volatility.

• Geographically, we prefer U.S. stocks (especially large caps) relative to other markets, as they offer better opportunities for both defensive positioning and growth.

• Across market sectors, we like health care as a relatively stable area and see opportunities in REITs, which offer a combination of solid fundamentals and attractive valuations. We also think the materials sector should benefit from easing inflation and energy should hold up well. We’re less favorable toward higher growth areas, including technology and communications services that are likely to struggle amid a “higher for longer” interest rate environment.