Welcome to the December 2022 Manager Panel! The Manager Panel is where we ask fund managers some questions surrounding a topic. This month we asked Harbour Asset Management, Mint Asset Management and TAHITO, some questions about their investment outlook for 2023. Check out the questions and answers below.

Q1: What do you believe are the top three things that will have the greatest impact on risk/returns in 2023?

The extent to which China re-opens
Until recently, most analysts had expected a very slow removal of COVID-19 restrictions in China, such that 2023 economic growth would be better than this year but not impressive. Recent policy announcements, however, suggest increased appetite to re-open more quickly. It also appears that the Chinese SINOVAC vaccine may be more effective than previously thought in protection against severe illness or death.

However, full re-opening of the Chinese economy likely requires a greater vaccination rate of the elderly and vulnerable. Should this happen quickly, economic growth next year could be as much as 6%, concentrated in H2, rather than the 4.5% expected prior to the recent announcements. This has important implications for both the health of the world economy next year (with China making up roughly 20% of global GDP), and New Zealand’s economic prospects (as China is our largest trading partner, taking about one third of all exports).

Whether the US can achieve a soft landing
Financial markets are pricing a high probability of a US recession next year. The US yield curve is the most inverted since the early 1980’s with 10-year yields sitting more than 80bps below 2-year yields. The implied volatility of US Treasuries is 90% of the average level seen in the past four US recessions.

The US Federal Reserve, however, believes a soft landing is possible where inflation returns to 2%, job losses are minimal, and a recession is avoided. Indicators suggest inflation is already heading lower, but the labour market remains the sticking point. There are currently 1.7 job openings for every unemployed person in the US. A soft landing hinges on the Fed’s ability to calibrate policy that will result in higher interest rates, reducing firms’ profitability and demand for labour to better match supply – but not forcing firms to shed labour.

A soft landing is far from consensus. Investor positioning appears to be pricing in a US recession. We can observe the low valuations relative to history for cyclical stocks and relative to less cyclical, defensive stocks. Additionally, the more conservative stance towards equities is reflective of the consensus outlook being one where a recession is expected. If a soft landing (while bringing down inflation) is achieved, this would be a significant positive for markets overall and could lead to a re-allocation towards cyclicals and away from defensives.

The extent to which earnings estimates change
Over the longer term, the key driver of a company’s share price performance will be their ability to grow earnings. However, over the shorter term, earnings announcements news can be swamped by other factors such as valuations. 2022 was one of those years. The sharp increase in interest rates gave rise to one the largest multiple contractions in modern history, though not one of the largest sell-offs due to earnings holding relatively firm. We expect share price performance in 2023 to be much more driven by earnings and, in our view, this could have significant implications for style and sector performance.

2022 has been a boon year for the more defensive utilities and healthcare sectors and a tougher one for longer duration stocks such as information technology, consumer discretionary and broader growth stocks. This is not lost on valuations or positioning, which shows investors are largely underweight growth equity sectors and overweight defensives, as consensus market expectations seem to be that the global economy will fall into recession some time in 2023. With bottom-up consensus expectations compiled by Bloomberg at 8.3% earnings growth in the US and 8.7% in New Zealand, analyst expectations are yet to catch up to the deteriorating top-down view.

Q2: What trends in the market or economy do you think will continue or emerge in 2023?

The push towards renewables will only get stronger
Europe has done well to avoid an energy crisis this northern hemisphere winter given the dramatic reduction in gas supply from Russia as it seeks to counter western sanctions associated with its invasion of Ukraine. Europe has successfully found alternative supply, and demand for gas has reduced due to rationing and a warmer winter than normal (so far). While it looks likely that Europe will enter next winter with ample inventory, there are several risks that include a drop in temperature or a pick-up in global demand for gas as China reopens.

Europe’s efforts to increase their energy sovereignty has seen huge investment in renewables. On top on this, it has seen households reconsider their reliance on the grid. One way we can measure this is through tracking installations of rooftop solar. For example, Enphase Energy recently reported a 70% quarter-on-quarter increase in solar sales to Europe. Add in the US’ Inflation Reduction Act, which energy consultancy Wood Mackenzie estimates will increase total spending on renewables to US$1.2 trillion by 2035, and the future looks bright for new energy over old energy.

 Q3: What are your projections for best and worst performing sectors in 2023 and why do you hold these views?

Within equity markets, we are wary of stocks which require a strong economic backdrop to perform, as growth may be challenged in 2023 with monetary policy tightening making its way through economies. We like the healthcare sector, which contains many defensive growth companies that can sustain and grow returns through a period of slower cyclical economic activity.

Although bonds have had a tough past 12 months, we think they are well-positioned to perform in 2023. The Bloomberg NZ Bond Composite 0+ year Index currently has a running yield of c. 4.6%, while the Bloomberg Global-Aggregate Bond Index yields 4.5% in New Zealand dollar hedged terms, (though it has touched over 5% in recent months). In terms of the Global Index, these recent levels of yield have not been seen since 2009.

We think that with central banks well into their tightening process, supply-side inflation moderating, and demand softening, a backdrop is created for stronger bond returns compared to recent years. Importantly, bonds are now at yield levels where they have plenty of room to rally if a non-inflationary macroeconomic shock were to occur. This more positive outlook for bonds, however, may be tempered by the ongoing constraints of large budget deficits, a large supply of government bonds and growing government debt levels.

This article does not constitute advice to any person (www.harbourasset.co.nz/disclaimer)

Q1: What do you believe are the top three things that will have the greatest impact on risk/returns in 2023?

We see the top three things that will have the greatest impact on risk / returns in 2023 as questions that need to be answered in the year ahead; Two focused on risk and one focused on returns.

The key question that the market needs to address is what does inflation being under control look like for a Central Bank? We believe the reality is this does not mean inflation needs to fall to the 2-3% target range for Central Banks to look to cut rates. Furthermore, we do not expect all Central Banks to view inflation in the same way as the US’ Federal Reserve. In fact, we see scope for some Central Banks to be cutting rates in Q2 / Q3 2023. However, if Central Banks want to see inflation fall below their target rate, this could have a severe impact on economies and markets.

The next question is – what impact have the interest rate rises in 2022 had on the economy ie will there be a recession? The reality is rising rates have knocked consumer and business sentiment and the rising cost of debt will increasingly weigh on disposable income as mortgage rates refix going forward. So we see a good chance that there will be a recession the depth of which will depend on how willing central banks are to stimulate domestic economies. Nevertheless, the stock market falls in 2022 have at worst partly reflected into share prices.

The final question is when will corporates be willing to invest again? The reality is that the best companies never stopped investing. But for many, macro uncertainties and supply chain disruption have meant that the visibility is not there to invest. Clearly those companies with stretched balance sheets will struggle, but on the whole corporate balance sheets are in good shape. So as macro uncertainties reduce, we would expect companies to look to take longer term investment decisions which should drive economic growth, even if this is likely to be more a 2024 story.

Q2: What trends in the market or economy do you think will continue or emerge in 2023?

We believe that both markets and economies will continue to focus on Central Bank decisions, and whether the Federal Reserve and other Central Banks are able to avoid pushing their countries into recession after an unprecedent rise in interest rates in 2022. So the outlook for 2023 is rather gloomy, even if this is the one of the most predicted recessions there has been and we see greater scope for optimism as the market focus moves to 2024 and beyond.

We expect rising interest rates to start to bite in early 2023 and start to weigh on discretionary income and the housing markets, particularly outside the US and here in New Zealand. This will weigh on market and corporate confidence and likely drive conservative outlooks for corporates in 2023 and beyond. Furthermore, we expect the rising costs of energy to continue to weigh in Europe. So we would expect market earnings expectations to continue to fall.

2023 should be the year of China re-entering the global market, having walked away from its zero covid policy after recent protests. Port congestion is falling as are freight rates, even if covid absenteeism remains an issue and global tensions remain high. We expect China’s production to largely return to the market and to be delivered broadly on time which we expect to have a deflationary impact. What is less clear is, what will happen to the Chinese domestic economy. After a year of covid affected growth in 2022, the market expects China to continue to stimulate its domestic economy in 2023 through further building programmes (and raw material consumption). Even if we believe this stimulus will be more domestically orientated than it has been in the past.

Q3: What are your projections for best and worst performing sectors in 2023 and why do you hold these views?

If Central Banks get it right, then there is likely to be no or a benign downturn. If they get it wrong there could be a prolonged global recession. Either outcome would favour a different set of stock and sectors. Given the uncertainties, we prefer to continue to invest in high quality businesses with strong balance sheets, high barriers to entry and competitive advantages that allow them to grow in most macro-economic conditions.

That written, we continue to see more solid fundamentals supporting Australian equities in comparison to New Zealand stocks and shares. Furthermore, with a recession 2/3s priced into global markets we continue to find investment opportunities across market sectors. With markets expected to trade sideways in 2023, before the macro-outlook becomes more certain, we hope that 2023 will be a year for stock pickers rather than macro driven themes sector themes.

Disclaimer: John Middleton is a Portfolio Manager of the Mint Australasian Equity Fund at Mint Asset Management Limited. The above article is intended to provide information and does not purport to give investment advice.

Mint Asset Management is the issuer of the Mint Asset Management Funds. Download a copy of the product disclosure statement.

Q1: What do you believe are the top three things that will have the greatest impact on risk/returns in 2023?

Inflation has been a major concern this year and is expected to continue into 2023. Our little nation is heavily export and import dependent. the primary sectors of meat, dairy, fisheries, wine, forestry and some horticulture products are our biggest exports with between about 70 percent and 95 percent of the output exported. Therefore, without trade, between 70 and 95 percent of those industries in New Zealand would simply not exist.

The recent International Monetary Fund (IMF) Report reaffirms that the global economy is experiencing a number of turbulent challenges. Inflation higher than seen in several decades, tightening financial conditions in most regions, Russia’s invasion of Ukraine, and the lingering COVID-19 pandemic all weigh heavily on the 2023 outlook.

Higher finance cost, the on-going European energy crunch with the War in Ukraine and further potential disruption in transport and logistics will likely see market volatility well in to 2023.

Q2: What trends in the market or economy do you think will continue or emerge in 2023?

The extra ordinary era of zero interest rates and easy money is now over. The unprecedented financial support during the pandemic is behind us as central bankers now focus on lowering inflation therefore, expect to see further growth slowdown and economic contraction in 2023. The more speculative assets like NFTs, crypto, and unproven venture-backed start-ups are already feeling the hurt.

Extreme weather events, livelihood crisis and climate action failure have been identified as the critical threats in the World Economic Forum’s Global Risk Report. It is imperative that Aotearoa NZ meets and ideally exceeds our international climate change and bio-diversity commitments to maintain trust and confidence with our trade partners. Issues around food security and nutrition quality should hopefully maintain demand for our food basket economy. The demand by investors for sustainable, ethical and ESG measures and validation will likely continue to increase in 2023.

The importance of Bio-diversity management, measurement and authentication is like to emerge further in 2023 as the markets and general public catch up with the science that shows the inseparable link between bio-diversity and climate change. Expect to see the transformation form wealth to wellbeing continue to playout over the medium term.

Q3: What are your projections for best and worst performing sectors in 2023 and why do you hold these views?

While the transition to renewable energy and circular economy principles need to accelerate, the requirement to provide heat and energy will likely continue to drive market performance in the less sustainable energy and mining sectors over the short term. The general economic gloom should favour non-cyclical and defensive stocks as well as more diversified conservative portfolios.

Should we see central banks pivot and signal interest rate cuts sometime next year, this should see a recovery of asset prices and better performance by growth and cyclical stocks in 2023. The downside is for a pivot to happen, it is generally accompanied with more economic weakness, unemployment and market volatility.