Power Letters 2023: Bal Krishen Rathore, chairman and CEO, Century Financial

The year 2022 has been a tumultuous one, with the Federal Reserve’s acknowledgement that inflation is not transitory and the subsequent rise in prices to a four-decade high of 9.1 per cent in June.

The ongoing Russia/Ukraine crisis and the Federal Reserve’s quantitative tightening, in which it reduces the size of its balance sheet by $95bn per month, have further exacerbated market challenges.

Previously favourable conditions, such as the Federal Reserve adding liquidity to the system, have turned into headwinds in 2022.

The Federal Reserve also implemented the most aggressive rate hikes, leading to a rise in US 10-year treasury yields from 1.51 per cent at the beginning of the year to 4.33 percent in October.

These factors have contributed to a 20 per cent decline in the SPX 500 and a 32 per cent drop in the Nasdaq 100. The ARK Innovation ETF, popular among growth stock investors, suffered a 66 per cent loss.

In 2022, volatility was also a prominent issue for investors, with bear markets often experiencing violent counter-trend rallies.

In 2023…
… the impact of a tighter monetary policy is becoming more significant, yet central banks are continuing to push forward.

The latest projections show that the Federal Reserve expects the median year-end 2023 rate for the fed funds rate to be 5.1 per cent, before being cut to 4.1 per cent in 2024. This is a higher rate than previously indicated.

However, investors are not convinced by the Federal Reserve’s hawkish projections and have a good reason for their skepticism. At the end of last year, the Fed expected the upper limit of its fund’s rate to be 1 per cent at the end of 2022, but it ended up being 4.5 per cent.

The Fed now predicts that the rate will be 5 per cent by the end of 2023.

Looking at the global growth outlook for 2023, we can expect deteriorating fundamentals due to tighter financial conditions and more restrictive monetary policy. The economy will likely enter a mild recession, with the labour market contracting and the unemployment rate increasing.

Consumers who saved money during lockdowns have mostly used up their post-Covid excess cash and are now facing adverse wealth effects from declines in housing, bonds, equities, and other investments. This negative trend is expected to continue in 2023, as consumers and businesses reduce discretionary spending and capital investments.

Going forward, markets are likely to shift from their current “bad news is good” mentality, where weak economic data is seen as signalling a change in monetary policy by the Federal Reserve, to a “bad news is bad” scenario, where fears of significant declines in profits and job losses could lead to further market losses.

Overall, the outlook for equities in the first half of 2023 is bleak, but there may be a rebound in the second half of the year.

Weaker demand, lower pricing power, margin compression, and tighter financial conditions will weigh on equities, but the transition from inflation to disinflation and a shift in central bank policy towards growth will support a recovery in risk assets in the latter half of the year.

Currently, the earnings estimates are on the higher side, however once analysts revise their estimates, it could turn out to be an opportune time to start accumulating equities.

In addition, low valuations may also attract investors and boost equity markets in the second half of 2023. Higher yields present opportunities for investors who have long been starved of income in bonds. Rising interest rates, widening spreads across sectors, and market volatility have significantly impacted fi xed-income total returns, making it one of the most challenging years for fixed-income investors in recent history.

Inflation and interest rate forecasts will remain crucial in 2023, as investors try to predict where rates will peak and when the Fed might “pivot” towards monetary easing.

Unfortunately, central bank policy rates cannot address production constraints; they can only affect demand in their economies. This leaves them with a difficult choice: either bring inflation back to their 2 per cent targets by reducing demand to levels that the economy can comfortably handle, or accept higher levels of inflation.

For now, they are opting for the first option.

In conclusion, the first half of 2023 is likely to be a challenging, but the latter half could see a recovery.