Stagflation is the main risk for the global economy in 2023

The primary risk to the global economy in 2023 is stagflation, according to investors who say hopes of a recovery after an aggressive downturn and this year’s selloff are premature.

Nearly half of the 388 respondents to the latest MLIV Pulse survey said a scenario in which growth continues to slow while inflation remains high will dominate globally in the coming year. The second most likely outcome is a deflationary recession, while an economic recovery with higher inflation is considered the least likely.

The results point to another challenging year for risk assets after central bank tightening, rising inflation and the impact of Russia’s invasion of Ukraine triggered the worst stock rout since the global financial crisis.

Against this gloomy backdrop and with stocks rallying in the fourth quarter, more than 60% of respondents said investors around the world were still very optimistic about asset prices.

“It’s still a tough year ahead,” said Nicole Kornitzer, portfolio manager of the Buffalo International Fund at Kornitzer Capital Management Inc., which oversees about $6 billion. “Certainly, stagflation is forecast for now.”

Meanwhile, about 60% of respondents expect further weakening of the dollar in a month. That contrasts with last month, when nearly half of respondents said they would go into the November Fed meeting with a long dollar position.

The strength of the US currency has affected many asset classes this year, including other currencies such as the euro and emerging market stocks. A falling dollar could create pockets of opportunity in 2023, which is already expected to be lackluster.

“The dollar is likely to weaken throughout 2023,” Kornitzer added. “Maybe not significantly, but the trend is likely to be bearish,” noting that the US recession and price direction will be the main catalysts for the currency.

All eyes are on the Fed’s move in 2023 with the potential to further slow the pace of growth as interest rates stay higher for longer, a system Fed Chairman Jerome Powell has previously warned against.

China and the danger of the “zero Covid” strategy for the global economy

Meanwhile, China’s strict “zero Covid” policy is another risk to the global economy as the number of cases hovers at record levels amid growing protests against the country’s coronavirus restrictions.

Escalating unrest in China sent oil futures and US stocks down. Bloomberg’s spot dollar index also fell.

More than half of respondents expect the S&P 500 to end 2023 in a lower or higher range of 10%. This is in line with the expectations of Wall Street, strategists at Goldman Sachs Group, Morgan Stanley and Bank of America. Among those who see the S&P 500 relatively flat for 12 months, all expect the sharp drop in earnings to weigh on the stock’s performance.

“Analysts will have to revise their earnings estimates downward,” said Annika Tryon, managing director at Van Lanschot Kempen in Amsterdam, whose firm has a conservative view on the stock through 2023.

And she continued: “We expect Europe to experience an economic downturn, like the United States. They will probably only be able to show modest growth, and China will no longer achieve its ambitions.”

However, despite all that pessimism, respondents said that US inflation was more likely to fall below 3% in 2023 than to exceed 10%, which would mean some relief at the end of the year.

That will be good news for Fed officials, who have already indicated they are inclined to move to a 50 basis point hike in December to mitigate the risks of excessive tightening.

In terms of opportunities, respondents to the MLIV survey see opportunities to grab long-term bonds and technology stocks, among others. Both asset classes have been hit hard this year by the sharp rise in interest rates.

Another potential risk in 2023 is developments in the housing market in the UK and Canada, with respondents seeing a 20% chance of a crash being 20% ​​more likely in those countries than in others. A jump in borrowing costs has forced some potential buyers out of the market and fueled predictions of lower property prices.

The majority of respondents ruled out the possibility of an escalation of geopolitical conflicts next year – for example China and Taiwan and NATO and Russia.

“The story of higher rates will dominate the first half of 2023,” said Ipek Ozkardeyskaya, senior analyst at Swissquote. However, in the third and fourth quarters of next year, we expect market statements to shift towards ‘low growth and stagnation’.

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