When I was writing this article last week, northern parts of New Zealand had experienced an extreme weather event, and our thoughts go out to those affected. A huge amount of rain fell over Auckland Anniversary weekend and when the relentless rain eventually stopped, I was left wondering if the worst was over – or if we were just in the eye of the storm. This provided an eerie parallel to financial markets– last year brought a financial storm of historic proportions, but 2023 has started on much stronger footing. Equity and bond markets have rallied in tandem. Will recent market strength continue, or are we braced for more turbulence as the year unfolds?
Headwinds turn to tailwinds in January
The start of 2023 has been a good one for investors. New Zealand’s NZX50 Index is up +4.3%, the US S&P500 Index gained +6.2%, and the technology-heavy Nasdaq soared +10.7%. After a challenging 2022, our portfolios have also started the year very strongly.
The rally has been driven by economic data which is in stark contrast to last year. In 2022 investors were fretting about inflation that seemed to continually soar higher, and the risk that rising interest rates would cause a recession. Recent data has shown that inflation has started to moderate, and the global economy is proving more resilient than many had expected. Global interest rates have also fallen from last year’s highs.
There is an old saying in markets that “as goes January, so goes the year”. Since World War II, if the market is up in January, it has continued to rise in the remaining 11 months of the year more than 85% of the time (for an average gain of 11.5%). Will this also be the case in 2023?
There are still clouds on the horizon
A strong start to the year is a nice change, but there are still challenges the market will need to digest this year. While inflation seems to be slowing, it is still very elevated by historical standards. We are also all aware that borrowers are facing big jumps in mortgage repayments, which creates the risk of a pullback in spending and a recession later this year. House prices are falling in New Zealand, which will put consumers in a cautious mood.
Although the economic data may be becoming more supportive – we aren’t out of the woods yet.
Focusing on the fundamentals
One thing I’m confident of predicting is that 2023 will be a year of surprises. Markets are unpredictable, and the journey as an investor is never plain sailing. In times of uncertainty, we believe it is even more important to screen out the noise and focus on the fundamentals of the companies we invest in.
Moving into 2023 the forecast is so far looking better than last year. Interest rates have moved materially higher. After years of investors being offered very low yields on fixed income investments – the prospects look much brighter. You can now get a 6-7% expected return lending to selected large investment grade companies. Two years ago, you would have only earned half of that. In 2022 share market prices fell so dramatically for some companies that we are now finding far more attractive investment opportunities, even after January’s rally. As we continue to focus on the fundamentals – screening out short-term economic noise – we are excited by the opportunities we see.
2023 won’t necessarily play out in a uniform or predictable way. New risks will pop up, there will be a lot of economic data for markets to digest, and no doubt bouts of market volatility. But after the 2022 reset, we believe the worst of the storm has likely passed, and long-term investors should be more optimistic about what lies ahead.