Policy backdrop
The consequences of
global policy tightening
26
out of the 31 central banks that we track are raising rates
Global wave of
higher rates
Almost in unison, central banks around the world raised rates in 2022 to combat inflation. Of the 31 central banks that we track, 26 raised rates, up from just two at the start of 2021.
Countries raising rates
Start 2021
Countries raising rates
End 2022
Forceful Fed
The U.S. Federal Reserve launched its most aggressive round of interest rate hikes in 40 years, disrupting global markets. By the end of 2022, U.S. policy rates will likely move above 4% for the first time since 2006. The European Central Bank (ECB) has followed suit, recently raising its policy rate by 0.75%, its biggest hike since 1999.
For the first time since 2006, U.S. policy rates will likely move above
4%
More expensive to borrow
Especially after many years of low rates and loose policy, higher rates and tighter policy make it tougher for consumers and companies to borrow. 30-year U.S. mortgage rates breached 7%, up from ~3.5% at the start of 2022.
The end of global tightening
We think the global tightening cycle will likely come to an end in 2023. Among the signs pointing in that direction: Growth is likely to slow, labor markets will likely soften, and inflation seems set to fall.
Economic Backdrop
Weakness across
the global economy
Growing friction
We expect friction in the global economy to continue to build. A recession in the United States and Europe is more likely than not in 2023.
United States
In the United States, activity in rate-sensitive sectors such as real estate and capital markets has collapsed. Economic weakness will likely broaden. However, restrained consumer and corporate debt and the lack of imbalances in the economy could act as buffers against a severe downturn.
For the first time since 2008, home sales fell by
~20%
Global value of initial public offerings fell by more than
$600b
The percentage of CEOs surveyed who are preparing for a recession is
98%
Europe
In Europe, contraction seems imminent. Reliance on Russian energy poses a risk even though natural gas storage levels seem full. Further ECB rate hikes to battle inflation will inevitably depress growth.
China
In China, the continued fallout from overinvestment in the property sector and strict COVID containment policy will likely continue to restrict economic activity.
Investment implications
Valuation resets
Pessimism priced in
It’s quite an array of challenges for the global economy.
For investors, one question is key: Where are you getting compensated for the risk you are taking? With global equities down 16% and the Global Aggregate Bond Index down 10% year-to-date, market prices have absorbed a good deal of risk already.
Lower valuations, higher yields
Along the way, valuations have declined dramatically. The forward price-to-earnings multiple of large-cap stocks has retreated to long-term averages, while bond yields are at their highest levels in over a decade.
Bonds
Treasury, corporate and municipal bond yields are at their highest levels in a decade, suggesting investors could potentially reach their goals by taking less risk. That’s a notable change.
Stocks
We think equity markets will find some stability in 2023 as higher valuations offset lower earnings growth.
We prefer the U.S. stock market and quality companies. Over the medium term, we see potential opportunity in U.S. small- and mid-cap stocks, where valuations have largely reflected potential damage to earnings.
Alternatives
Anemic public market activity means private market investors can earn a premium for providing both debt and equity financing.
We also see potential investment opportunity in areas critical to stability and security: infrastructure, transportation, natural resources and real estate.
