After a robust start to the year with inflation easing, some stock markets reaching double digit returns, and bond yields reaching 15-year highs, economists and investment strategists are feeling more confident that recession risk is receding in H2 2023, according to a survey by Natixis Investment Managers conducted at the end of June 2023.
Drawing on the insights of 32 market strategists, portfolio managers, research analysts and economists at Natixis Investment Managers and 13 of its affiliated investment managers, as well as Natixis Corporate and Investment Banking, the survey reveals that 50% rate recession as a low risk in H2, but that said, they remain cautious, warning that market headwinds are intensifying with an uncertain picture for H2 emerging.
Nearly three quarters (72%) are concerned that inflation may linger longer than expected and 38% think rates could stay high for longer than anticipated, as 66% also worry about corporate earnings, finds the mid-year survey.
Surprising start to the year
The first half of 2023 surprised strategists and investors. In November 2022, 59% of institutional investors believed recession in 2023 was “inevitable” and 54% said recession was “absolutely necessary” to curb inflation*. The reality is a different picture as markets delivered solid returns, bonds generated attractive yields, and inflation began to ease around the world, dropping to 3% in the US.
The survey reveals that over the rest of 2023 just 6% of strategists believe a recession is “inevitable”, 53% say there is a “distinct possibility”, and 9% think recession is “highly unlikely”.
Inflation: from high anxiety to easing prices
After a painful run of increasing costs, central bank efforts to ease the pressure began to produce results in H1. In the US, inflation shrank from 6.5% in June 2022 to 3% by the end of H1 2023, while in the Eurozone it fell from 9.2% to 5.5%. The UK has failed to keep pace, but is starting to show signs of inflation easing, falling from 10.5% at year-end to 8.7% in May.
Only 22% of strategists surveyed say inflation is a “high risk” in the second half of the year, however, 38% of strategists do not believe inflation targets will be met until 2025, and 9% say they may not be met until at least 2026.
Investors shouldn’t be complacent as headwinds remain
Geopolitics (72%) and central bank policy (72%) draw the strongest consensus when it comes to headwinds. However, a quarter (25%) of strategists do not think geopolitics will impact markets in the second half of the year, instead calling geopolitical issues “noise”. Bank policy concerns centre around the question of how high and for how long rates will remain restrictive before inflation is back to target levels.
Corporate earnings are a potential headwind for 66%, however 25% are optimistic and say earnings may act as a catalyst in the second half of the year. Strategists are also split on the outlook for consumer spending as half worry a slowdown in spending will serve as a headwind, while 28% believe consumer spending will increase providing a catalyst for market growth.
“Inflation is cooling off, but we aren’t through the woods yet. Strong consumer spending, inflated cost of services, and geopolitical tensions may keep inflation lingering for longer which will result in higher rates for some time yet. Strategists generally think it will take until 2025 until targets are met,” said Mabrouk Chetouane, Head of Global Market Strategy, Solutions, Natixis IM.
Finding opportunities
When considering the headwinds and opportunities, 34% of the market strategists say the US is best positioned for the rest of the year, and 22% think either Japan or emerging markets (excluding China) will be the winner. Just 16% think Europe will be the leading market, while only 6% believe it will be China. None of the strategists are backing the UK. There is strong consensus that large caps (81%) will outperform small caps (19%), in part due to tighter credit standards set in the wake of Q1’s banking crisis.
Strategists are torn between whether growth or value will outperform to year end, seeing a 50/50 split.
Bond markets
After 15 years of low and negative yields, yield returned in 2023. As central banks hiked rates to the highest levels since the global financial crisis, investors took advantage. Yields on 10-year Treasuries reached 3.84% in June as 10-year Eurozone Central Bonds reached 3.21%. Asked for their outlook on H2:
- 47% think US Treasury yields will come in at 3.5%-4%
- 41% see rates receding, leading 28% expecting 10-year Treasuries to drop to the 3%-3.5% range
- 13% think rates could move to between 2.5%-3%
However, there are still concerns for fixed income investors:
- 72% worry inflation may linger longer than expected
- 38% think rates could go higher than anticipated, 38% also believe they could stay high for longer than expected, and 38% are worried about corporate defaults and downgrades
- Largely strategists are not worried about consumer credit and the housing market as only 13% say they are concerned, but 69% see central bank mistakes as a risk (53% medium risk and 16% high risk)
With all things considered, 56% of those surveyed think long-duration bonds will outperform short-duration bonds by the end of 2023.
Equity rally likely to cool
Markets rallied in the first half of the year, largely due to the re-emergence of tech. The NASDAQ delivered returns of 30% – the best H1 in the index’s 52-year history. The tech rally, driven by excitement around artificial intelligence (AI), also helped the S&P 500 gain 15.91%. In Japan, corporate reforms and a focus on sustainable growth saw the Nikkei to see returns of 27.91% by June 30 – the biggest gain in 33 years.
However, none expect the tech rally to intensify, less than a third (31%) expect it to “continue steadily” and 6% of strategists think the “bubble will burst”, so expectations should remain realistic. Half think equities more generally will cool off in H2 and prices will dip to reflect the fundamentals.
When asked specifically about AI, while 88% believe it can unlock previously undetectable investment opportunities and 69% believe it will accelerate day trading, 100% of the strategists surveyed believe it will increase potentially fraudulent behaviour.
“Compared to expectations at the end of 2022, 2023 has been surprisingly positive so far, but investors need to stay alert to ongoing headwinds to prevent complacency. Inflation has gone from an all-consuming concern to a manageable situation in most developed markets, but it could take some time before aggressive targets set by central banks are met.
“Big tech helped equities come roaring back in the first half of the year but, while few predict a major downturn, most are concerned about corporate earnings across H2 and expect the rally to fade away by the end of the year. Recession is still a real possibility, but most expect a softer landing. The successes of H1 may dissipate, but our strategists and economists still believe there are good opportunities if you look carefully,” said Mabrouk Chetouane.
The full survey report can be found here: https://im.natixis.com/intl/markets/2023-strategist-outlook-turn-the-page
