As we enter the new year I thought of these lyrics from the song ‘Closing Time’ by Semisonic, “every new beginning comes from some other beginning’s end.” Many have their 2023 economic and market guesses and soothsaying projects and I’ll just throw in what I feel are the most relevant factors to consider. //www.youtube.com/watch?v=xGytDsqkQY8
As for the equity bear market, I don’t know exactly how it progresses from here as the consensus seems to be down 1st half and rally in the 2nd half but the consensus is usually wrong. All I’m confident about is it ain’t over. The biggest financial bubble in the history of bubbles, that being in sovereign debt, and everything in turn priced off that risk free rate, doesn’t end with the S&P 500 down just 20%+ off its highs. It doesn’t end at 17x multiples. It doesn’t end at a price to sales ratio not far from March 2020. It doesn’t end without a notable earnings recession (I’m talking $180 or below this year as higher inflation recedes and it was the only thing providing revenue growth at the same time higher interest rates and wage costs compress margins). It doesn’t end with credit spreads nowhere close to previous wides. It doesn’t end until everyone throws in the investing towel not wanting to ever own a stock again. That said, buying stocks in a bear market is the best time to do so as tremendous values are created.
But it isn’t easy reconciling how things play out in 2023. On one hand I’m worried about the trajectory of economic growth but I also believe the full reopening of China in Q2 will be a huge economic positive. However, one that might mostly be positive for China, the rest of Asia and parts of Europe such as Germany that do huge business with China. The US doesn’t export much there. It will certainly be good for commodities and the countries that produce a lot of them such as some in South America.
I’ve expressed my worries many times here about the leveraged loan market and all those companies that have exposure to floating rate debt, including many small businesses with their local banks. For reference, the leveraged loan market is about $1.4 trillion in size (not including bank loans given to small businesses), about the same size as the US high yield market. For those with IG or high yield debt, the risk isn’t as much in 2023 and 2024. Steve Liesman on CNBC last week highlighted in a chart that the massive maturity wall for these two groupings won’t be hit until 2025 and 2026. It totals about $1 trillion in 2023, goes to almost $1.4 trillion in 2024 and then more than doubles to $3.25 trillion in 2025 and just above that in the year after. So those that have termed out their debt for the next few yrs will be much better off than those who didn’t or didn’t hedge their floating rate exposure.
Energy will still be a huge issue for Europe as we progress thru the yr because it will be much harder to refill gas storage going into next winter. The war in Ukraine is not ending anytime soon. And, the reopening in China will lead to MUCH higher crude oil prices I believe, something north of $125 per barrel. I read last week that according to the International Energy Agency in September, China was on track in 2022 to purchase the smallest amount of oil since 1990. Let that sink in with prices currently still near $80. Oil prices are going much higher I will repeat and I’m not just talking back to $100 and $125 could be conservative. We remain long energy stocks, particularly European majors that trade at half the multiple of US ones and we also own natural gas stocks.
Speaking of China, the unleashing of the Chinese consumer and tourist beginning in Q2 will be massive I believe. I don’t think people appreciate how important they were pre Covid and after being essentially locked up for 3 yrs, having them back will be a huge economic factor. According to UN data, in the 5 yrs leading into Covid, Chinese tourists spent about $250 billion per year. Just a week ago, Trip.com (a stock we own) said that sales for travel tickets rose 4x over the previous day. Pre Covid, according to Bain & Co, the Chinese consumer made up 1/3 of global spending on luxury items vs between 17-19% in 2022. In a Bloomberg story last week, they quote a 26 yr old Shanghai resident who had Covid and said “I can’t wait to embrace the freedom and make a long distance trip with my friends. Three years have been wasted. Omicron cannot deter me. I’m so thrilled to be setting off in two weeks’ time.” Multiply that feeling and action by the many millions.
I remain very bullish on the Asian economies and markets (particularly India, Singapore, Vietnam and Japan) as a result of this as they are major beneficiaries of not just the Chinese consumer but also a rebound in the overall Chinese economy. According to the WSJ, pre Covid, about 1/3 of tourists to Japan and South Korea were Chinese. About 25% of visitors to Thailand were Chinese in 2019. In the FT last week, they quote someone from the Shenzhen based head of McKinsey’s Asia travel practice who said, “Pre-pandemic, China was the world’s largest source of outbound tourists, with 150mm travelers going abroad each year.” He forecasts international trips by Chinese travelers would be 50% of 2019 levels by the summer vs 5% just recently. That will eventually get back to 100%.
I am still very much of the belief that longer term bond yields will surprise to the upside even in the face of falling inflation and economic growth, although China’s reopening could reverse those two factors. I remain worried about the impact of more ECB rate hikes and QT at the same time we’ll likely see more YCC spread widening when Kuroda leaves at the same time US budget deficits and debts might FINALLY matter for investors and the Fed continues on with QT. This in turn will lead to a higher 10 yr US yield. These regions were the epicenter of the global bond bubble. There are so many more attractive high quality bonds to buy with maturities no further out than 2-3 yrs.
Inflation will fall notably this year as the goods price inflation continues to reverse and rent growth continues to slow. Maybe we’ll even see some zero y/o/y prints by yr end. BUT, that is NOT where inflation will end up settling out at in 2024 and it will be 3-4% rather than 1-2% for reasons I’ve stated many times before. Thus, any rate cuts by the Fed in the back half of 2023 will be limited, if it happens. And if I’m right on oil prices, headline inflation will really get whipped around this year.
Gold, which had a great year in 2022 relative to just about everything else, will do well in 2023 as the headwinds of a very aggressive Fed and coincident strong dollar are just about over.
With this new era of structurally higher interest rates and the end of negative rate policy, mostly, hopefully forever, “Closing time, one last call for alcohol, so finish your whiskey or beer. Closing time, you don’t have to go home but you can’t stay here” said also by Semisonic.
With China now fully reopening as we know but along with the mess the current situation creates (however necessary to absorb as China is damned if they reopen and damned if they lockdown), the economic data is terrible but should be viewed as old news. The Chinese economy now has a hall pass from the markets just as the US had a hall pass as it reopened. My friends at the China Beige Book said “Q4 data are, unsurprisingly, a bloodbath.” The December Caixin manufacturing PMI fell to 49 from 49.4 and PMI’s in Taiwan, Vietnam, South Korea and Malaysia all remained below 50 but should improve in the coming months and quarters as China rebounds. PMI’s in India, Indonesia and the Philippines all rose m/o/m and remained above 50.
Germany will report a drop m/o/m in its December CPI at 8am est and a moderation y/o/y and expectations of this has European bond yields lower for a 2nd day and it’s why US Treasury yields are down. Germany also reported a better than anticipated December jobs report as the number of unemployed fell by 13k instead of rising by 15k as forecasted. The euro though is getting hit as the US dollar is higher across the board.
Europe enters 2023 with the price of TTF Dutch natural gas at the lowest level since the few days before Putin invaded Ukraine. Warmer weather is now helping as it is in the US in lowering the price of natural gas.
Dutch TTF Natural Gas