The global economy and markets were rattled by two significant shocks in 2022: an inflation shock and an interest rate shock. Going into 2023, one expected shock to the economy remains: recession. Amid this backdrop, BofA Global Research economists and strategists released their outlook for 2023, noting the year should be a story of two halves. The U.S., Euro Area and UK are all expected to see recessions next year, and the rest of the world should continue to weaken, with China a notable exception. The recession shock likely means corporate earnings and economic growth will come under pressure in the first half of the year, while at the same time, China’s reopening offers a reprieve for certain assets.
“This past year has seen significant market volatility due to surging inflation, geopolitical risks, and central banks hiking at paces not seen in decades,” said Candace Browning, head of BofA Global Research. “In 2023, inflation should come down, but it will take time for central banks to declare victory. Next year will continue to present uncertainties in the markets but also opportunities for investors willing to be patient and choose their spots carefully.”
Key macro calls made for the markets and economy in the year ahead are:
1. Markets turn “risk on” in mid-2023: With inflation, the U.S. Dollar and Fed hawkishness peaking in the first half of 2023, markets are expected to tolerate more risk later in the year. The S&P 500 typically reaches its bottom six months ahead of the end of a recession, and as a result, bonds appear more attractive in the first half of 2023, while the backdrop for stocks should be better in the later half. We expect the S&P to end the year at 4000 and S&P earnings per share to total $200 for the year.
2. A recession is all but inevitable in the U.S., Euro Area and UK: Expect a mild U.S. recession in the first half of 2023 with a risk that it starts later. Europe likely sees recession this winter with a shallow recovery thereafter as real incomes and likely overtightening pressure demand.
3. U.S. Rates stay elevated but expect a decline by year end 2023: The yield curve is expected to dis-invert and rates volatility should fall. Both two-year and ten-year U.S. Treasuries should end 2023 at 3.25%. Sectors hurt by rising rates in 2022 may benefit in 2023.
4. China’s reopening happens but could be bumpy until later in 2023: China’s gradual reopening is underway, with most curbs expected to be removed by the second half of the year.
5. After a volatile start to 2023, Emerging Markets should produce strong returns: Once inflation and rates peak in the U.S. and China reopens, the outlook for Emerging Markets should turn more favorable. China equities will likely strengthen due to a reversal in both zero-COVID and property tightening.
6. After a historically bad year for industrial metals in 2022, cyclical and secular drivers are expected to boost metals in 2023, and copper rallies approximately 20%: Recessions in key markets are a headwind but China’s reopening, a peaking U.S. dollar and especially an acceleration of renewables investment should more than offset these negative factors for copper.
7. Higher for longer oil prices: Russian sanctions, low oil inventories, China’s reopening, and an OPEC that’s willing to cut production in case demand weakens should keep energy prices high. Brent Crude is expected to average $100 per barrel over the course of 2023 and spike to $110/bbl in the second half of the year.
8. Reshoring capex remains strong, even in a recession: A strong labor market, ESG, U.S./China decoupling, and deglobalization/reshoring are expected to keep certain areas of capex strong, even in the event of a recession.
9. The U.S. consumer gets some relief on prices, but also becomes less willing to spend given the wealth effect and as labor markets worsen: Labor markets should finally ease in 2023 and the U.S. unemployment rate should peak at 5.5% in the first quarter of 2024, hindering consumer spending.
10. The end of Fed hikes and more conservative corporate balance sheet management lead to a positive backdrop for credit: Weaker prospects for growth and higher rates lead managements to shift prioritization to debt reduction from share buybacks and capex. Total returns of approximately 9% are expected in investment grade credit in 2023 in addition to a default rate peak of 5%, far below past recessions.