by Andrea Malcolm
As we enter 2023, headline inflation appears to have peaked in many developed economies, though core inflation is expected to prove more stubborn despite a pause in interest rate rises. However with a lot of bad news already priced in, this year may prove to be a better year for markets, but prudent and active security selection is vital as plenty of risk remains, according to Salt Strategist Greg Fleming.
“We've had quite patchy data from retail in New Zealand with card transactions down, property transactions down, all these things falling away at a time when costs are still very high. It’s affecting all business,” says Salt Strategist Greg Fleming.”We’re in a waiting period where the lagged impact of interest hikes from the central banks could still be running for another nine months at least.”
The critical question is how much tighter monetary conditions need to become for central banks to believe they have done enough to constrain demand, rebalance supply and demand conditions in labour markets, and achieve their inflation objectives.
“We think that interest rates probably won't won't rally much further from here, that they'll probably trade in a range until there's more clarity on inflation.”
This uncertainty is likely to see bonds, which rallied strongly in January after an all-time recorded low in 2022, plateau. That’s good news for real estate which is likely to prevail thanks to its flow surety, inflation-hedging qualities and, in the case of infrastructure, resilience to non-cyclical forces. For fixed income classes in general, thematic assets are a differentiator with infrastructure being a favourite of Salt and sustainable or “green” bonds emerging as a valuable theme.
With a recession or near nil-growth on the horizon, default risk and credit quality are likely to become a market focus later this year and into next. This will set off portfolio re-allocations within and beyond bonds.
Fleming says equities, as a whole, will potentially see average annual returns close to their long-term norms in the next three years with interim weaker periods but selected equity sectors and markets have desirable investment features and scope for resilience.
Salt is actively “all weather” securities across all its asset classes, as they are resilient to both inflation and to profit challenges in a less stimulus-based, capital spending and productivity-led phase of economic growth.
“When recovering from a bear market, there can be periods of optimism that cause a rally. Advisors shouldn't be trying to chase those momentum rallies,” says Fleming. “Instead they should focus on the fundamentals of where the economy is going and stay defensively oriented. You wouldn’t want to go back to growth sectors, stay in those that have regular cash flow revenues. They still have great merit in recession risk periods which we're in.”
Defensive stocks include utilities and consumer staples, healthcare, and IT’s software as a service (SaaS) have pricing power which will help them ride out sentiment squalls and hedge against economic slowdown.
Meanwhile de-rating in very overvalued equities (specific companies such as the social media giants) is now advanced but Salt doesn’t anticipate a resume in that bubble.
Fleming says expect more mergers and acquisitions based on strong US dollar “war- chests” as shifting conditions see some corporate courtships founder and distressed firms abound.
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