As this is the last column for the year 2022, it is an opportune time to reflect on the performance of financial markets, the global economy, and factors that defined the year 2022. What started as a promising year quickly turned into a nightmarish year for most investors as Russia’s invasion of Ukraine and the resulting impact on the global economy had a devastating impact. Global economic growth was slashed along the way by both the World Bank and the International Monetary Fund (IMF), while inflationary pressure, mainly due to the record high commodity prices, and the unprecedented hikes in global interest rates, were the two key themes driving investors’ sentiment and markets.
For Malaysia, the year 2022 too was a defining year as the Bank Negara Malaysia (BNM) joined other central banks in raising the Overnight Policy Rate (OPR) but obviously at a much more measured and at slower pace of increase than its regional peers. Malaysia was also in the limelight as the recently concluded 15th General Election (GE15) provided an unexpected outcome with the formation of what is now defined as a unity government, comprising some 148 Members of Parliament – a first for the nation, and one that is hoped will be able to remain in power until the next polls are called in five years.
An Economic Recession Year?
It is inevitable that major economies will enter into a recession in 2023 as the writings are certainly on the wall. The J.P.Morgan Global Composite Purchasing Managers’ Index (PMI) and the J.P.Morgan Global Manufacturing PMI for November were last seen at 48.0 and 48.8 – both at a new 2½-year low and consistently below the 50 threshold mark, which separates growth and contraction, for the past four and three months respectively. Recent economic projections also showed dire expectations with the US Federal Reserve lowering its growth outlook for 2023 to just 0.5% from 1.2% three months ago, while the World Bank also recently slashed China’s 2022 GDP growth to just 4.3% from 8.1% projected earlier.
Global economic growth is still very much intact but there will be periods of short recession experienced by major economies in 2023 and that by definition is an occurrence of two consecutive quarters of negative GDP growth on a quarter-on-quarter basis. The US experienced a technical recession in 2022 when Q1 and Q2 economic data points showed a 1.6% and 0.6% contraction respectively. However, for the US, it is not a recession yet until the National Bureau of Economic Research (NBER) says so, whose main job is to identify the dates of peaks and troughs that allow the bureau to frame economic recession and expansion periods. Typically this occurs months after the actual recession had begun or ended as the bureau typically awaits confirmation based on multiple data points. Hence, as far as NBER is concerned, the US was not in recession in 2022.
But the Market Thinks So
The US yield curve has never failed to identify an incoming recession in the last five decades and it is unlikely that the signal it is providing now is any different. While the surge in the short-end of the curve is understandable, given the hike in US interest rates, the behaviour of the longer-dated treasury papers seems to suggest that investors are concerned on the longer-term economic momentum and have already started pricing-in expectations that the Fed will start to cut rates. The US 10-year minus the 3-month treasury yield curve at the time of writing was last seen at -52bps, an improvement from the recent depth of -90bps, but still signalling that the US is in for a recession within the next 12 months. In fact, the US yield curve is inverted all the way from the 6-month US treasuries up to the 10-year papers. Hence, while the Fed is seen still raising rates into 2023, and peaking at between 4.75%-5.0%, based on Fed Fund Futures, the market is also pricing-in expectations that the Fed will cut rates to stimulate economic growth. Given that market tends to trade at least six months ahead of Fed’s move, it is likely that the market has already priced in these expectations, which is positive for equity markets going into 2023.
Dump the Dollar
The Dollar, which was one of the best-performing currencies in 2022, is set to be weaker in 2023 on the back of lower Fed Fund Rates as rates may be cut by as much as 100bps going into 2H of 2023 as the economy takes a tumble from the current high borrowing cost and elevated inflation prints. With the projected drop in US interest rates, Emerging Market (EM) currencies will be on firmer footing this year as most economies will likely see the peak in benchmark interest rates.
With the expected rate cuts, comes market expectations as to how asset classes will behave. Naturally, the fixed-income market will be a sweet spot as the current relatively high rates would suggest that yields will come off, which indirectly means bond prices will be higher. The 2021/2022 rate hikes had indeed taken a big hit on the fixed income market as from a peak of US$18.4 trillion (RM81.4 trillion) to a mere US$254 billion (RM1.12 trillion) this week – negative yielding debt papers suffered a staggering 99% evaporation in the market value over a space of little over two years. With rates seen going south, the fixed-income market is seen to be the greatest winner among all asset classes in 2023.
Covid-19 May Haunt China
China has finally come to reality in dealing with the Covid-19 pandemic as it has not only changed how death is defined when it comes to fatalities but also is now prepared to open up the economy fully, by first removing the quarantine time requirement for overseas travellers with effect from Jan 8, 2023. China has effectively made a complete U-turn with respect to dealing with the Covid-19 pandemic as it moved away from the “Zero-Covid” mantra to effectively a “No-Plan” strategy. While official data suggests the number of cases is under control with a 7-day moving average of about 3,700 cases per day, the reality on the ground seems to suggest the number of actual cases is many times higher than that and in some reports runs into millions per day. This will be manifested in other economic data points in the months to come as the pandemic takes its toll on the economy and until China can holistically address the pandemic, it is one virus that is not going away anytime soon and could prove to be a key point when forecasting Chinese economic growth in 2023.
A Tale of Two Halves
Based on Thursday’s market close, the year 2022 was certainly a washout year for most global equity markets as major US indexes fell by between 8%-33%, European stocks were lower by a little over 10% while Asian bourses, except for marginal gains of between 4-5% in Singapore, Jakarta and Mumbai and a flat close for Bangkok’s main index, saw losses of between 5%-25% in local currency terms. In US Dollar terms, other than a 4% gain in Singapore’s Straits Times Index, all other Asian bourses were lower with losses ranging between 4%-34%. Going into 2023, there are certainly more headwinds for equity markets and chief among them are earnings expectations, slowing consumer demand, worries of the sustained and persistent inflation rate, and flow of funds as the Dollar may still be a mighty attraction for investors in early 2023. However, the tide is expected to turn in the second half of 2023 as investors perceived accommodative central banks policy to cut rates as positive for equity markets. At the same time, inflationary expectations too will likely drop while prolonged recession fears will more or less disappear. The key element of global markets for 2023 is also the re-opening of the Chinese economy as the world’s second-largest economy puts Covid-19 concerns to rest as simply a flu-like virus.
Global Liquidity – Withdrawal Syndrome
From the peak of about US$31.6 trillion (RM139.5 trillion), four major central banks have seen a meaningful drop in the total size of their respective balance sheet, which presently stands at about US$27.8 trillion (RM123 trillion). The Fed has reduced its balance sheet by as much as US$400bil (RM1.77 trillion) to US$8.56 trillion (RM37.8 trillion). The European Central Bank’s balance sheet is presently at US$8.5 trillion (RM37.6 trillion), down some US$910bil (RM4 trillion), while the Bank of Japan and People’s Bank of China are at US$5.25 trillion (RM23.2 trillion) and US$5.50 trillion (RM24.3 trillion), down by US$900bil (RM3.98 trillion) and US$1.55 trillion (RM6.85 trillion) respectively. The 12% reduction in global liquidity by four major central banks alone had significant implications on markets as it has reduced the amount of liquidity that was available supporting over-valued assets brought about by cheap money since the days of the 2008/09 Global Financial Crisis (GFC) and boosted further by cheap money printing machines due to the pandemic.
The question is with the Fed projected to stop its quantitative easing program, are we going to see the Fed shrinking the size of its balance sheet consistently at US$95bil (RM419.9bil) per month, and for how long more, given the economic challenges faced in 2023. While some have thrown the idea that the Fed may shrink its balance sheet by between US$2 trillion (RM8.84 trillion) and US$3 trillion (RM13.26 trillion), which suggests that the Fed will remain in its Quantitative Tightening (QT) mode for the next 17-27 months before it turns neutral. Can the market withstand such an enormous amount of liquidity taken away? The other question that investors may have is how would the rest of the three major central banks react to the QT path that they have taken so far in 2022, as well as throughout 2023 and into the Fed’s QT path. Will central banks co-ordinate their QT programs or if the Fed stalls on its QT, will other central banks follow suit too? Investors will be paying close attention to the size of the central banks’ balance sheets as this will dictate the direction of capital markets.
As we usher in the year 2023, the Russian invasion of Ukraine is reaching its first anniversary soon, and clearly, there are no signs that either Kyiv or Moscow is anywhere near ending the war that has killed at least 200,000 from both sides, if not more. The economic fallout from the war is severe to the global economy and for Europe in particular as it battles to reach energy sufficiency due to a cut in supply from Russia’s energy sources. While some are resorting to re-activating coal-fired power plants, others are reviving defunct mines and opening new ones.
The China-US relationship took a positive turn with the meeting of President Xi Jinping and the US President, Joe Biden in mid-November 2022, whereby key issues relating to US-China bilateral relations, including China’s economic development, Taiwan, and regional security were discussed. Nevertheless, the year 2023 will be key to the bilateral relationship as China begins to open up its economy fully and open its borders while Chinese listed companies in the US remain under pressure due to actions by the US in imposing certain sanctions or ban on exports of the products to the US.
Malaysia – It is all about the Reform Agenda
With Datuk Seri Anwar Ibrahim as Malaysia’s 10th Prime Minister, all eyes are on him to bring about the change that Malaysians have been yearning for, especially with respect to structural reforms that have been discussed in depth in previous write-ups under this column. From lifting wages to affordable homes, from a greater allocation for healthcare and education to good governance and strong budgetary processes, from strong leadership that Malaysia solely misses to a government that listens to the need of the people, failure is not an option for Anwar’s government.
Two key events to watch will be the re-tabling of Budget 2023 on Feb 24, 2023, and a couple of political battles that loom ahead, including UMNO’s party elections and the upcoming six state polls, which will likely take place by mid-June or July 2023. Economically, Malaysia will see slower growth this year of approximately 4%, mainly due to the higher base effect from 2022 as well as the slowing global economy. The 100bps hike in the OPR thisyear too will work its way in reducing consumer spending and investments. With the US set to cut rates, especially towards the 2H of 2023, Malaysia and other EM are seen to be a net beneficiary with the Ringgit expected to regain most of the lost ground in 2022 while the fixed income market is seen as a sweet spot as benchmark papers are seen to have peaked this year. Equity markets too look attractive, with the KLCI trading at just thirteen times the price-to-earnings ratio, the upside potential has been seen much clearer than the downside risk.
In summary, the year 2023 is a challenging one for the global economy but markets are near pricing in the headwinds before us. With the Dollar set to reverse its course and China getting ready to open up to the world and central banks turning dovish in time to come, it is an opportune time for investors to pick up bargains from both two key asset classes – fixed income and equities. For now, the reduction in global liquidity and potential geopolitical tensions are seen as unknown factors and may or may not impact investors’ sentiment. However, as far as Malaysia is concerned, the new government formed post GE15 is seen as one that will put Malaysia back on the radar of foreign investors with the right agenda, and its ability in addressing structural issues will be the key catalyst for the market.
Next week, this column will discuss in greater detail on interest rates and justify reasons as to why BNM may stand pat in 2023 with OPR left unchanged at 2.75%, contrary to market expectation which is looking at a 25-50bps hike, on the back of persistently high monthly inflation prints.