Bright spots for equities and signs of relief on the bond market: the 2023 investment year is likely to turn out better than the last one, but overall still volatile. For investment strategy, the rule remains: invest as broadly diversified as possible and don't let yourself be thrown off course.
Ben Bernanke, former head of the US Federal Reserve, is regarded as a proven expert on monetary policy as well as on the interplay between the economy and capital markets. In 2022 he was awarded the Nobel Prize in Economics. On the occasion of the award, he was asked whether he had any advice for young economists. His answer: "One of the lessons of my life has been that you never know what's going to happen."
Not all experts admit so candidly that the future holds surprises and that developments cannot be predicted. Yet this in itself obvious fact is especially important for investing. quirion's investment strategy deliberately does not rely on forecasts. It systematically aims for such broad global diversification that short-term trends cannot knock it off course. "Reminding yourself of the general conditions from time to time is nonetheless worthwhile," emphasizes Arndt Kussmann, Head of Investment Communication and Analysis at Quirin Privatbank and at quirion. "That can protect investors from being lured out of their investment approach by supposedly hot stock tips or sharper price swings."
Less pressure from inflation and rate hikes
As for the swings of the past year, inflation and central bank policy were among the major stress factors. Historically high rates of inflation as well as sharp interest rate hikes by central banks sent equity and bond markets into a tailspin. That both markets weakened at the same time was historically an exception – but for many investors particularly painful.
So where do these stress factors go from here? "There are several reasons to believe we have already seen the peak in inflation," Kussmann observes. For instance, there were first signs of relief in electricity and gas prices, which is especially important for developments in Europe. The global supply chain problem has also eased recently. "From today's perspective, a slight decline in inflation rates to six or seven percent is realistic in the eurozone over the coming months." Should the situation in the energy sector ease more markedly than currently foreseeable, a faster decline in inflation rates to four percent or less would also be possible.
On interest rate hikes, the US Federal Reserve and the European Central Bank did recently ease the pace, but at the same time they signaled that the rate-hiking cycle was not yet over. "In the eurozone, we expect the key interest rate to rise in 2023 from the current 3.0 to between 3.5 and 4.0 percent," says Kussmann. In the US, further slight rate hikes into the region of around five percent are also likely.
Bright spots for equities
Rising key interest rates are generally negative for equity markets. After all, refinancing becomes more expensive for companies. "If the global economy also weakens, as is clearly emerging for this year, that is certainly a further burdening factor," Kussmann explains. "That is likely to have a negative impact on corporate profits as well." But he and his colleagues on Quirin Privatbank's analysis team consider severe profit slumps unlikely. And besides: "An economic soft patch has been a topic of discussion for quite some time now. It's quite possible that this is already largely priced in and that the markets are already focusing on a by no means improbable profit recovery in 2024."
Because share prices fell more sharply in 2022 than the profits to be expected, most equity markets are also rather cheaply valued, measured by figures such as the price-earnings ratio (P/E).
That the P/E ratio is also below its long-term average in the US is rather rare. "We haven't seen it like this for quite some time," Kussmann observes. One reason for this is, among other things, the slump in the heavyweight technology sector.
The share prices of many tech companies were driven sharply upward during the coronavirus pandemic. But the associated, particularly high profit expectations made them vulnerable to disappointment. In addition, the interest rate hikes had a negative effect specifically on growth companies. The background: when calculating the current company value, rising interest rates mean that future profits are worth less from today's perspective – known in technical jargon as discounting. The higher the future expected profit growth and the further in the future it lies – both of which often apply precisely to tech companies – the more strongly interest rate hikes weigh on the discounted present value.
The US remains the pacesetter
Kussmann, however, considers a lasting weakness of the technology sector unlikely. Overall, the sector structure of the US equity market is now somewhat more balanced again. "That's positive," Kussmann finds. "The US stock exchanges remain, as they have for many decades, the pacesetter for most equity markets." Before they reclaim their accustomed role as the front-runner in performance, however, it will take time.
The eurozone economy could even fare somewhat better than the US this year thanks to the lower interest rate pressure. But the European equity market continues to be shaped by great uncertainties, above all the war in Ukraine and the associated energy crisis. China, meanwhile, has to cope with the aftermath of an immense wave of coronavirus following the end of its constant lockdowns. This could make supply chain problems in Europe worse once again and weigh on the global economy as a whole. "But in our assessment, a protracted economic crisis would not grow out of this," Kussmann affirms.
Well positioned for the long term
Despite all the risks, the chances are good that the performance of the equity markets at year-end will turn out considerably better than in the past year. There are also signs of relief for the bond market, which the interest rate turnaround weighed on very heavily in 2022. "Thanks to the rapid rise in interest rates, new investments finally deliver returns that lie noticeably above the zero line again," Kussmann underscores. "We've waited a long time for that." Existing, broadly diversified ETF portfolios will benefit in future from the "reinvestment effect": when bonds mature, they are automatically replaced by new, higher-yielding bonds. "That should offset the price losses of 2022 over the medium to long term."
After a number of adjustments to the global and to the sustainable portfolio, they are better positioned than ever. "Because our investment strategy generally doesn't rely on forecasts, that holds true even if the year unfolds differently than we currently expect."
