We believe the beginning of 2023 will likely bring a recession and more stock-market declines — perhaps beginning between now and the end of January. Since this recession will likely end in late 2023 or early 2024, and the market will discount the economic upturn by 6–12 months, we think stocks can likely rally later in 2023. This is the history of almost all recessions for the last 60 years. If the recession were to end by April 2024, we would probably see the market bottom between July and October 2023.
Major Trends for 2023
What will a recession do to emerging markets, developed markets, currencies, bonds and stocks?
Emerging Markets
Commodity-producing countries may have a tougher time than those which produce goods and services for export. Domestic growth will be more difficult for all emerging countries, because higher interest-rate costs will make real estate and industrial expansion expensive. High and rising labor costs will impact the richer countries in the emerging world, especially China; China will outsource more manufacturing to Vietnam, Cambodia, Thailand, Laos, the Philippines, Bangladesh, and other nearby countries. China will have the world’s highest nominal GDP growth at about 4–5% — but inflation-adjusted GDP growth will be negative.
Developed Markets
The U.S., Canada, Australia, Europe, Japan, Taiwan, Korea and developed Asia will experience a recession in 2023. Lower commodity prices will make this a recession of average severity — not the hardest, not the easiest. The U.S. and the rest of the developed world experienced a brief and mild recession in mid 2022; recession will return once again in 2023, but in a more severe manner. Labor costs will catch up with the inflation of the last two or three years, and this will keep inflation in the U.S. above 5%.
Currencies: Major Trends
We believe the strong U.S. dollar has peaked and will fall in value modestly versus the world’s major currencies (euro, yen, and pound). The dollar can continue to rise versus the most important emerging market currencies — the Chinese yuan and the Indian rupee.
The dollar’s strong rally in most of 2022 has somewhat suppressed inflation in the United States, and has put pressure on commodities traded in dollars such as precious metals and oil (and other energy commodities). We believe that will reverse in 2023, and that we will see support for precious metals, European currencies, and the Japanese yen; although we could also see the Canadian and Australian dollars appreciate modestly, we believe the greatest currency appreciation could be in the Japanese yen. It is significantly oversold, and we believe it will rally in 2023.
The Chinese yuan will become a more important vehicle for international trade, but at a very slow pace. The Chinese banking system is still closed to free-market international transfers because China relies on total control of its banking system, with no outside influences, to manage its domestic economy and political affairs. Therefore, predictions that the yuan will soon become a world reserve currency are incorrect.
Commodities
Gold and silver should perform well under the conditions we anticipate. Uranium should do well, because world opinion has strongly swung in favor of nuclear power. Many countries are building out more nuclear capacity — small reactors especially — but this will take a few years to mature. Demand for uranium will rise at about 10% this year, and more uranium mining facilities will be brought back on stream that had been shut down for 10 or 20 years.
Base metals will perform decently because the U.S., Europe, and developed Asia will slow more than China. We think commodities are likely to begin outperforming after the first quarter of 2023.
Recession Effects
In the west, we anticipate a recession of medium severity, with unemployment rising particularly in the technology sector and marketing industries due to weak advertising spending and weak consumer spending on goods and services. Conditions will likely be hard for the retail and food service industruies and their suppliers. Growth stocks in technology and consumer services which have high P/E ratios and low (or still-unrealistic) growth rates still face selling pressure.
Focus on low-P/E growth and strong balance sheets, where profitable companies can finance growth by internal cash flow. Outside financing will dry up, and inflation will increase costs. Avoid cash-flow negative software and ESG-related companies that will take years to attain profitability. Less private capital will be available from venture capital firms for such companies; they will not be able to replenish their balance sheets easily in the equity market, and bond buyers will shy away from their high-yield instruments. Private equity firms will pull back deeply on their buyouts of companies, and the entire alternative financial space — leveraged loans, venture capital, private equity, etc., will contract significantly.
We note that even with recession in 2023, some stocks may have seen their lows in 2022.
Recession Will Not Do Away With Inflation
Inflation will likely fall to about 5% and then rebound again in a few years. This second wave of inflation will arise because the monetary and fiscal policies of the U.S. policymakers, and those in other developed economies, will not allow wise reduction of spending. So monetary policy will tighten, but fiscal policy will be unwisely loose.
Indeed, inflation from services and labor costs has become embedded, and will keep overall inflation high; the goal of 2% or even 3% inflation will likely prove unattainable. We run the major of risk of a return to the problems of the 1970s: very slow growth and embedded inflation due to the massive debt that the developed world has loaded on their balance sheets during the era of post-financial crisis and pandemic spending.
At the same time, politicians in the developed world have not cut spending, and indeed, have used fiscal spending in a manner that undercuts the intelligent use of monetary policy to slow inflation. The socialist strategy of making people more dependent on government has been adopted by both major political parties, and this is going to lead to an outcome much like the 1970s. In the early 1970s government’s high-spending “guns-and-butter” policies allowed inflation to rebound strongly after the punishing recession of 1973 and 1974. Ill-advised wage and price controls did not work, but made things worse, and inflation psychology became embedded among consumers and wage earners as they realized that they had to fight for higher wages. The same is likely within two years from the end of the recession that we anticipate in 2023.
Attractive Countries for Investment In 2023
China
China should have nominal GDP growth of 4–5% in 2023 due to rollback of its zero-covid policy. Now that President Xi is in power for at least another five years, China will use more coal and industrial metals, and continue to suppress any internal Chinese opposition or business magnates who speak out against the regime.
We anticipate that China will build up its defense industry, build more naval and air power, and enlarge its army. It will ally with Persian Gulf states, Iran, and Russia to build and strengthen an economic and political front against the U.S. It will try to broaden the payment of commodities transactions though the Shanghai commodity exchange in order to conduct more payments directly in yuan, which will slowly strengthen its status as an international currency. Still, the yuan will not approach the importance of the U.S. dollar as a medium of foreign exchange for a long time.
China is abandoning its zero covid policy, and this will make the country and its stock market more attractive.
We do not expect a big housing-driven boom in China because the sector is already too highly levered, but we do expect a renewed push for exports from China. We like Chinese retail and travel stocks, and companies which can adapt by outsourcing production to the nearby workshop countries of Southeast and South Asia.
China has made arrangements to import energy from the Middle East and Russia, and its growth will not be affected by energy scarcity woes. Xi is now a strongman leader; he is unopposed, and he will do what is necessary to maintain power. No public opponents will dare to speak out against him and his political and economic goals. We expect more military spending and alliances to strengthen China’s position and a world economic power — not with developing countries through the “Belt and Road” system, but with real energy suppliers and major non-aligned countries. Some progress will be made, but unless China opens up its banking system it will only do yuan business in trade, and not in global financial systems.
Europe
In spite of the energy crisis and recession, Europe has potential for 2023. The euro will likely rise in value, which will supplement profits in European stocks for U.S. buyers — while today’s lower euro will help European manufacturers and retailers gain market share in Asia and North America. Asia — especially China — will be a good market for European and American goods. Certain European banks are well-positioned, particularly in Holland, Switzerland, and the UK; they will likely benefit form the recovery of the economy.
India
India will show positive economic growth and benefit from some shifting of Chinese production to India. Services will migrate faster to India than manufacturing because of the kludgy and inefficient infrastructure prevalent in India, and the massive and corrupt bribe-taking bureaucracy standing in the way of rapid progress.
India has developed new relationships with Middle Eastern oil producers, and this is very important to their growth. India has massive coal reserves, but very little oil and gas. And it is a country where electrical, water, gas, and transportation services can be cumbersome and slow-moving. A company operating in India must prepare to supply almost all of its own utilities and transportation for their employees, and services — even real estate transactions — can be immensely complex.
Due to the complex caste system, even having a company meal or picnic is a very complex operation. Therefore, on-line work is a good way to go in India, and manufacturing is very complicated.
India has had a movement away from the Fabian socialism of its founding fathers to a more quasi-capitalist system in the last 10 years, and is now moving toward more free markets and less corruption. Computer services and communications have greatly increased Indian productivity. India has many brilliant citizens, and will continue to develop and grow very successful companies from within. With 1.3 billion people, they are also a destination for consumer and technology goods from abroad. Within India, we favor call centers, tech-related technical services, farm equipment, generic drug manufacturing, insurance, stock market related, banking, and production of traditional packaged food.
Asia Ex-China
Vietnam, and possibly Cambodia, are well-positioned to be the workshops for manufacturing activities that are being moved from China due to the rise in salaries within China. These are frontier-type countries, and if they can manage their transportation and worker availability, they have excellent prospects. Their business is based upon exports, and not the production, of raw materials which will be more difficult to export during a developed-world recession.
Thailand has long been a workshop country of Japan in the auto and other industries, and will benefit form Japanese growth.
Much like Japan, South Korean companies in the auto, heavy equipment, electronics, shipbuilding, transportation, and other industries should grow in 2023, especially in the second half of the year.
Japan
As we noted above, after the massive decline in the Japanese yen until November 2022, we anticipate a rise in the value of the yen in 2023. We anticipate that like China, Japan will provide economic opportunity in 2023. Japan has many strong companies and is a major exporter of manufactured goods. They will benefit from a decline in raw material costs in 2023, and they will also benefit for non-Japanese investors, as the yen will likely appreciate from its currently oversold position. We look for Japanese autos, steel, electronic, heavy equipment, transportation and other goods to sell well in 2023, especially in the second half of the year as the developed world returns to growth.
Stay tuned for further reflections next week.
Thanks for reading; we welcome your calls and questions.
