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RBC Brewin Dolphin’s 2023 investment outlook: a year of recession, inflation peaks, and bond returns

A ‘mild’ recession, inflation easing, and interest rates peaking should make next year a bit brighter for investors after a challenging 2022, according to RBC Brewin Dolphin.

Among its predictions for 2023, the wealth manager believes inflation should ease sharply, which should have a knock-on effect for interest rates and financial markets.

Guy Foster, chief strategist at RBC Brewin Dolphin, said: “2022 has been a challenging year for global investors. There were many sources of anxiety and stress for the markets, including sky-rocketing inflation, the surge in interest rates and the building risk of recession.

“The impact of the fastest US rate hiking cycle in history will reverberate more visibly in the economy in 2023. The much higher cost and hurdle for borrowing will lead to some painful, but much needed adjustments to imbalances from a personal, corporate to national finances perspectives.”

A mild recession ahead

Guy Foster said: “While a recession in major developed economies looks inevitable, the length and depth of it is likely to be mild. The labour market remains in good shape with job openings in abundance. Financial institutions are well capitalised and are unlikely to experience the kind of liquidity crunch of the 2008 financial crisis. Governments around the world are shielding the most vulnerable from the surge in energy cost and there are still plenty of pandemic household savings to cushion the cost-of-living crisis.

“That said, with the cost of borrowing rising significantly, there will be inevitable adjustments to the years of excesses and imbalances built up in the economy. That could mean a downturn in the housing market, a reduction in borrowing by households, de-leveraging by corporates, and more fiscal prudence by governments in 2023.”

Inflation pain to ease

Janet Mui, head of market analysis said: “The main source of pain in 2022 was arguably the persistence of eye-watering inflation, which had a knock-on effect on monetary policy and economic activity. The good news is that inflation is likely to slow sharply in 2023 for a number of reasons.

“Commodity prices, including wholesale oil and gas, have fallen notably. Inventories of goods are building up and shipping costs are falling rapidly, which are good signs for price pressures to fall.

“Historically, interest rate rises impact the real economy and inflation, with a lag of 12 to 18 months. Inflation of goods and services typically eases as demand falters in a recession. So, once inflation comes down, we can anticipate better times ahead.”

Interest rates to peak and pause

Janet Mui said: “We think the bulk of large and rapid rate increases are behind us in major developed economies. The Fed Funds Rate is likely to peak at around 5%, while the UK Bank Rate will likely peak around 4.5%.

“The hawkish tone from Federal Reserve officials has softened a bit recently, as they acknowledged there is a time lag between policy and the impact on the real economy. Meanwhile, the Bank of England’s Governor has decisively pushed back against previously elevated market interest rate expectations.

“These suggest to us that while central bankers are determined to fight inflation, they know they have already done a lot in a short time span, and they don’t want to overtighten and crash the economy unnecessarily. Whether interest rates will be cut in 2023 depends on how quickly inflation comes down. At a best guess, interest rates will plateau and stay high, and cuts are more likely a 2024 story.”

Bonds to be more attractive than equities

Janet Mui said: “Despite the economic uncertainty and market volatility this year, we believe opportunities for long-term investors are emerging. We think there are pockets of attractive opportunities in bonds after the surge in yields and spreads this year. Investors are now able to lock in decent yields while taking little, in selected investment grade credit, to no credit risks – for example, in developed market government bonds – with the potential for attractive price returns when interest rates eventually fall.

“The conviction on equities is less clear in 2023, as weak growth and earnings could drag the market lower before a decisive fall in rates helps equities bottom. Throughout history, equities tend to deliver superior long-term returns. Timing the market is difficult, but the declines in prices we have seen this year give investors the ability to buy good companies at more attractive valuations. Our preference remains on quality companies with strong balance sheets, pricing power, and sustainable business models.”

China to gradually reopen

Janet Mui said: “There are more concrete signs that the Chinese government is softening its stance after widespread protests. We think the overall direction remains constructive, where the worst of Zero-Covid restrictions are behind us. The normalisation of Chinese activity will be incrementally positive for global demand, at a time when recession looms in 2023.

“Retail investors and, indeed, the market will remain very sensitive to Covid developments in China. There is a general sense of FOMO – fear of missing out – in case there is a big rally, which could support retail trader momentum.

“While the markets may have got ahead of themselves and, before we get overly excited, we should recognise the challenges and complexities involved in the reopening process. Over the longer-term, investors are likely to remain concerned about the political, geopolitical, and regulatory implications after the cabinet reshuffle by President Xi at the National Party Congress.”

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