Market Outlook - What will drive the markets in 2023

The New Year can be full of surprises, as there exists a vast amount of uncertainty and a mix of negative outlook & optimistic hopes globally. The main factors in focus are Fed's interest rate hikes, fear of global recession, and covid situation in China.

American Market

The difference between the US 10Y bond yield and US 3Y bond yield has turn negative. This is considered as a sign of upcoming recession. The 3Y bond yield is trading around current yield of 3.98% and the 10Y bond is trading around 3.56%, the difference being -0.42%.

How come the negative difference a sign of recession?

The logic behind this goes back to concepts of present value of money and also the relation between time and risk. Longer the time, larger will be the risk that an investor is taking (be it interest rate risk, inflation risk, market risk, default risk or any other risk). Hence, he will demand a higher rate of return on his investment. Also, a rupee today worth more than a rupee tommorow (due to inflation) .So, longer period bond shall have higher yield than that of a shorter period bond.

Another factor is the interest rates, there are clear signs that Fed will not be reducing the interest rates as the fear of rising inflation is still haunting. FED has already increased interest rates 7 times in 2022, driving interest rate from 0% to 4.5%.

Although, the rise in non-farm payrolls and the dip in unemployment rates are showing signs of cooling labor market, but investors are still concerned about the rising interest rate and the fear of recession.

 

EUROPEAN MARKET

The ongoing war between Russia and Ukraine has adversely affected European countries. Apart from the war, high inflation in UK, strikes by employees in UK, German unemployment, rising inflation are some other factors which are adversely affecting the European markets.{Although, UK is no longer a part of Brexit, I have mentioned it here just because of its geographical location}.

Inflation: Although, the energy bill rebates offered by Germany has heavily influenced the inflation data (of Euro Zone), pulling down the headline inflation from 10.1% in November to 9.2% in December. But the core inflation (which excludes fluctuations in food and energy prices) rose 0.6% in December to a new height of 5.2%. The rise in core inflation is a sign of rising inflationary pressure on economy.

The situation of European countries is even worse than the West. We can say that many European nations are dealing with recession-inflation or stagflation. {Stagflation is a situation where inflation is rising to new heights, and growth is very slow. It is a situation of dilemma for economic policy makers}.

Natural Gas: The prices of natural gas skyrocketed when Russia escalated military invasion on Ukraine {refer to the chart below}, but due to low demand from developing countries and Asian economies, price of natural gas has fallen sharply. This has been so far beneficial for European countries. But since the winters have just arrived, the situation may soon reverse, if either there is an increase in demand for natural gas from developing nations or if temperature fall below the average level.

Russia-Ukraine War: the only beneficiary of this war is the United States of America, which is selling LNG to European countries at 4-6 times the price of pipeline gas of Russia. The European countries are totally on the negative side. This, in fact, raises a question that... How long will NATO  (especially its European allies) will fund Ukraine? They themselves are on the verge of a recession.

 

Asian Markets

China: If we look at Asian economies, rising covid cases in China is one of the biggest drivers of financial markets, affecting not only Asian markets but other markets also. The worst part is that China no longer has any reliable data on the covid situation. It is reporting relatively lower number of cases and deaths. This is a cause of worry, as we know very well what happened to the global economy, financial markets, and all the people when corona virus started spreading.

Japan: Japan is also on the verge of falling into stagflation. Japan’s PM Fumio Kishida has asked corporate leaders to accelerate wage pay hikes, because if the price growth is greater than wage growth, the economy will fell into stagflation. Japanese Yen has strongly depreciated against US dollar since 2022(refer to the diagram below), as the Bank of Japan (BoJ) didn’t increase its interest rates, even though the inflation was touching new heights. Yen appreciated against US $ from November 2022 through December 2022, due to many factors like FX intervention of BoJ, expectations regarding hawkish policy of BoJ, and expectations that Fed will reduce the interest rates.

India: The only exception to the whole world is India. India is witnessing strong domestic demand, which edges away the fear of stagflation. The inflation is also within the tolerance limits of RBI (current CPI- 5.9%). Banks are witnessing strong credit growth along with falling NPAs and improving asset quality.

The only cause of worry is that though domestic demand (as measured by private consumption expenditure, increased by 9.7% YoY) is increasing, the manufacturing sector has shown a negative growth of -4.8% (YoY). This indicates that the domestic demand was met by imports. In Q2 of 2022-23, Imports shot up by 39.9%. Since, payments for imports has to be made in foreign currency, usually US $, this puts a burden on the forex reserves. This further leads to depreciation of Indian rupee. Else, India is doing well as compared to other economies.

 

Conclusion

-        Uncertainty is a factor which has a strong influence on financial markets. Nobody want to invest their money in Somalia or Syria, the reason being that there is no security of investment and the return on it. Since, we have now seen the uncertainty, due to recession fear, inflation, covid situation, it is strongly suggested not to invest a large sum of money as of now.

-        Buying on dips, may be a good strategy but that too in those sectors which are having favorable conditions. Like, metals, banks, and also automobiles (Indian) as they have shown increase in sales(in terms of volume also) but prefer those companies which are having a high share of revenue from domestic markets, as the global outlook is either uncertain or negative as of now.

 

Shaurya Gupta
Bcom hons, University of Delhi
Financial Market hons, Yale University

Text is subjected to copyright. You can use the text but kindly do not publish this content.