this year has been one of the most difficult on record for a combined Bond and Equity portfolio
and as a result of this performance many professionals have been forecasting an
imminent recession but at the same time the U.S labor market has remained relatively resilient
in this our last episode of 2022 we'll look at 10 key charts for next year if 2022 was the year
of the price shock will 2023 be the year of the growth shock that's the big conversation [Music]
investors love to hear trade ideas but in some ways what's more important than that
is to have a market framework that helps to identify the key risks and challenges to
our views the best investors always say that risk management is more important than idea generation
so using 10 charts we'll look at some of the key Battlegrounds that could Define the outlook for
2023. we're going to kick off by looking at the us because that's obviously where most
of the real Battlegrounds do lie at the moment but then we're going to Branch out and look at
some of the things in the rest of the world some of them look unconnected but all these
are in many ways part of the same framework now looking at the US I think the key thing here is
that we've got uh recession are we going to get a recession how deep will that recession be and
then what's going to be the policy response do we get a pivot or a pause and the first chart I
want to look at which really gets the Crux of all this is unemployment and recessions and it might
seem obvious but really unemployment is probably going to be the main factor next year that defines
whether we get a recession and how deep it will be and then ultimately what happens within the
equity market and this first chart really brings home the importance of this relationship because
if we go back to the 1960s you can see that unemployment has started to turn before a a
recession starts on almost every occasion there are a couple in the period of inflation in the
70s where it did turn just as we hit recession but the point here is that we haven't really started
to move meaningfully higher in unemployment yet now obviously unemployment is prone to revisions
it's a very backward looking data point and already we can see disparities between the
establishment survey and the household survey and we're starting to see anecdotal evidence that we
are getting job left particularly within the tech sector but what should really strike us about this
chart is that recessions and higher unemployment come hand in hand so far we are not seeing a rise
in unemployment in fact we normally see the big acceleration in unemployment during the
middle of a recession so this suggests that the recession if there is going to be one is still
some way in the distance perhaps there isn't going to be one but then that brings a problem
for the FED because the FED trying to fight price would worry about growth if unemployment doesn't
pick up and growth stays relatively robust so the speed with which unemployment picks up is
even with revisions which we can expect to come through and the amount of unemployment that we
get so how high will unemployment go is going to be one of the key factors if not the key factor
for defining the sort of recession that we're going to get now one of the key elements around
that in terms of what could cause unemployment to pick up significantly we've seen obviously the
tech sector starting to shed jobs but I really think it goes down to housing and construction
this very very big sector which employs a lot of people and if we look at the nahb housing index
I've inverted it here and I've mapped it on to that unemployment index you can see that the two
pretty much ebb and flow together except that the NH nahb housing index generally leads unemployment
so far we've seen this quite incredible move on this chart it's up but actually that's the
index of the nahb index falling it's been one of the biggest moves that we've seen in the last 20
years it's a faster Pace than we saw during the midst of the mortgage crisis of the 2006-2007
period and it only just lags behind that shock of covid this certainly suggests that unemployment is
going to pick up with a lag to this decline in housing and obviously construction being
an important part so we've got to keep our eye out on that unemployment data because it feels
like these are the points that are coming through some of them anecdotal suggest that
unemployment will pick up and therefore we will get a much bigger recession but obviously when
we look at unemployment and recession there is a bit of chicken and egg here sometimes it's a
recession that creates unemployment sometimes it's rising unemployment that creates recession but
nonetheless a two-go hand in hand even if they are coincident and the two are very much going to be
the drivers of the next chart and the next chart is the s p 500 because you could be saying well
unemployment okay recession bad for households Etc but what about financial assets when you map the
s p onto recessions you can see that there is a major low in the s p either in or just after every
single recession that we've had so if we still got a recession ahead of us because we've still
got unemployment ahead of us then potentially we still have a major low in the s p ahead of
us now there are one or two caveats that we can look at here which might say okay maybe there are
an alternative there is an alternative scenario the first one was 1980 and 82. these were two
recessions but we did get a higher low in 1982 than in 1980. so if we get a big enough kind of
inter-recession rally then that's one potential similarly if we haven't actually had a recession
yet is the potential for the equity Market still to Rally further from here so the recent low that
we've seen in terms of 2022 is not the actual low and that maybe the comparison there is 1987
to 9 1991 where the market did manage to Rally but it does fall from that housing data and from
the anecdotal evidence from the tech sector that unemployment will pick up sooner rather than later
and therefore it feels like that recession story is probably one for 2023. then the next chart
I want to show you is one which is yields versus the s p because obviously this year it's been all
about those higher prices higher inflation and the policy response of a hawkish fed and Tighter rates
that's meant that bonds are sold off and yields have gone up at the same time that the s p has
sold off now as we film this um at the beginning of December so in the first couple of weeks of
December we were starting to get some signs of yields falling and Equity starting to fall at
the same time now the reason why this matters is that we've been adjusting for price in 2022. this
was all about prices getting ahead of themselves in terms of what most people expected even though
some forecasted and then the FED having to catch up and then going Beyond expectations and then
Bonds in particular adjusting for that with higher yields bonds selling off and the equity
Market sold off generally led by the tech sector within this we actually saw many stocks performing
pretty well so lots of rotations will we now get that correlation event where all equities
sell off and this is why that unemployment data is so important because why'd you get
lows during periods of higher unemployment well that's because you get redemptions you
get liquidations because if you fear job losses or potential losses of future earnings you will
sell down some of your Equity Holdings in order to offset that which is why we get these correlation
events during those recessions and that's when we get everything selling off which means that
some of the winners of 2022 could become losers in 2023 not necessarily the losers but just because
we've had that good performance particularly in the commodity sector we get a true proper
recessionary slowdown then you normally get correlation and pretty much all equities sell
off together doesn't mean they sell off by the same amount like we saw often in 2008 but it does
mean that there could be risks to some of those best performing stocks from 20 20 from 2022 so
we've got to be wary that we could move from bonds down equities down to bonds up and equities down
a very different Dynamic and in fact if we look at the inflation period of 19 the early 1980s we
actually saw that when bonds started to roll over those yields started to fall so bonds started to
Rally yields started to decline we actually got more performance from bonds than we got from the
equity Market yields had actually often Fallen substantially before equities made a proper low
and then started to rally and often they ran it again once growth picked up so we have to
be careful that we don't interpret the current environment like we did between 1985 and 2020
when that period you saw two-year yields falling as interest rates were being cut before we got the
rump of the equity Market sell-off that was the period of moderation when the Fed was supporting
growth this is a period where they are fighting price like they were in the late 70s and early 80s
so it could be a very different dynamic and we can see this now in when we look at things like the
yield curve and this is already playing out in in very much real time at the moment in that again at
the beginning of December we've seen the two-year 10-year portion of the yield curve this is 10-year
yields minus two-year yields has gone to minus 85 basis points which is the steepest inversion that
we've seen since 1980 and 1982 and this kind of makes sense because if the FED is truly fighting
price and not worrying too much about growth until they've got a control on price then they will
continue to raise rates until they think they have got a handle on prices now there comes a point
when those higher rates should impinge on growth so long-rent yields 10 years and 30 years should
continue to fall relative to two-year yields which should stay sticky or even rise and even if you
get a shift down in the curve so all yields falling in this environment where the FED is
doing more than people expect growth and inflation expectations at the back end should fall if they
really have got a handle on price that starts to impact growth so you would expect the yield curve
to invert and again this goes back to comparing to that period of moderation because there's still a
lot of people who expect the yield curve to invert and then start to re-stepen into a recession and
therefore into the lows in the equity Market but again that was that period of moderation
go back to 1980 and 1982 and here you can see that the yield curve carried on its inversion to its
deepest inversion deepest inversion right into a recession with lots of volatility in that yield
curve it went up it went down in terms of that steepness but it carried on going down into the
recessions this could be the same thing where they keep on being quite tight at the front end and
the back end prices at growth with those yields falling so the yield curve could be that indicator
that starting now that tells us that this could be much more like 1980 1982 than any period in
between so this then comes all on to what's the policy response from the FED because at the moment
there is this pivot versus pause type of view and a lot of people think that the pivot is simply a
pause which as I've said before it's not to me a pivot is you raise rates and then you cut rates a
pause is you raise rates and then you pretty much hold them at the moment the fed's fund curve is
still really looking at this being a pivot and you can see this in the early part of next year
it's really q1 and Q2 you can see this v-shape which is is that V shape is when the interest rate
um cycle is currently being priced to turn now the FED funds curve has not been a brilliant
predictor so far we've gone from around about four percent in terms of the terminal yield uh terminal
interest rates back in September it's gone to five percent just above just below and we've seen the
Pivot Point move from February through April we're currently around about May so it's not necessarily
the great predictor but what really matters here is that will the FED want to Pivot early because
there is already a recession well they want to pivotally because they think a recession is coming
or they want to continue to tighten until they know that there is a recession that caps prices
and historically the FED has never been preemptive they've never gone oh we think there's a recession
coming therefore we're going to stop and turn they nearly always wait for the recession because the
big risk for the FED is that if they turn too early and risk assets rally and we actually get
growth coming back before they've got a handle on on prices so inflation then inflation could
could pop back something that we saw regularly in the 1940s and 50s where you had sequences of
Peaks and similarly in the 1970s there were three consecutive peaks of inflation they won't want to
do that they won't want inflation to get ahead of themselves they will probably want to make sure
that unemployment picks up so that we don't get wages getting sticky which is where you
often get that really entrenched inflation from if it's simply Commodities and effectively the
supply chain then once that rolls over we could be in a safer position but if wages become sticky
that's when you start to get inflation and so they won't want to turn too quickly the market
is still pricing a pivot well we see that pivot move towards more something like a plateau which
would be a pause that's the real sort of main Battleground at the moment but outside of the us
we've also got some very significant areas that we should be watching and one is that this probably
will be a global slowdown if and when it happens and what are the signs that we can see that where
can we witness this happening and we can see this in things like currencies now so far this
year the Japanese Yen has been on the back foot it's been on the back foot because they've been
doing yield curve control they've also had the issue with importing energy so the energy costs
have been going up that's been diluting the Yen the Yen has been very weak but over the last few
months it has been consolidating versus the Aussie dollar now the Aussie dollar is normally that sort
of on off risk on risk off growth no growth type of currency because it's an export of Commodities
Aussie dollar versus Japanese Yen Aussie dollar has been performing very well over the last two
years but it's been consolidating and now it looks like it's got the potential to start breaking down
so if you want to look outside of the U.S and some of the ideas that the global growth story
is starting to really come unstuck then Aussie dollar Yen would be one because Aussie dollar
rolling over versus the Yen would mean that the yen is not having the problem of the higher yields
perhap potentially not from higher inflation which has been the problem in 2022 and the Aussie dollar
is not getting the benefits of higher prices and commodities largely because the high prices that
we've had have not been combined with a lot of demand and a lot of volume going through so we can
watch the Aussie dollar versus the Japanese Yen for signs that the global growth story is starting
to come unstuck and then if it does do we see some of last year's winners as I mentioned before in
the U.S Equity Market but the global market do we see some of last year's winners or 2022 winners
starting to come unstuck in 2023 and here we've got the footsie now this is a long chart of the
footsie the full of Old World stocks so therefore lots of energy companies lots of mining companies
and lots of Staples companies this is still near the all-time highs and it's done relatively well
over this year having underperformed things like the US for a very long time but the point here
is that if we get a true recession a true Global recession then even things like energy stocks and
Mining stocks despite the long-term positive story because of this massive Supply demand
imbalance over the next 10 years these stocks will come under pressure because remember the story
during covid even though Supply demand imbalances existed in the energy and commodity space when
demand collapses you can see that Commodities and commodity stocks can have a difficult time
as well it wouldn't be as bad as that we won't get Negative oil like we did back then but you can see
it comes Under Pressure the issues existed before covid they were laid there after covert when we
had that demand impulse from the fiscal and the supply shock because of Kobe closing things down
similarly if we have a true recession in 2023 then we could see some of that demand falling
and so even some of these boring stocks from 2022 could come under pressure and the ftse 100 which
has held up so well may be one of those which struggles relative to how it's done in 2022 then
just turning very slightly away from from the sort of equity market we've got to look at the
energy Market because the energy crisis was very much the story through the middle of the year but
it's kind of died to death towards the end of 2022 but it's just been deferred it's not been removed
from the the environment it will come back and the issues are still very much there and when we look
at things like base load this is the front month future base load electricity in Germany I've used
a log chart here because when we use the non-log chart it looks like it had an enormous Spike and
came all the way back down to its starting point but on a log chart you can still see it's roughly
three times higher than pretty much the highs of the previous 10 15 years energy costs are still
high within Europe the energy crisis is still there bubbling away in the background at the
beginning middle of December there is a cold spat going through Europe that could cause a few of the
supplies that have been kind of built up to get drained and therefore we could be facing another
issue with energy throughout 2023 and even into 2024 this has not been removed it has only been
deferred and so therefore energy is going to be a very serious story throughout the next year then
finally I've left inflation to the end because I could have started off with the US CPI chart and
we could have said Has It peaked is it going to roll over quickly enough but that inflation story
is one which is is going to play out globally and I wanted to come on to Japan because we talked
about Japan already and yields in Japan and the Japanese Yen but what matters with Japan is that
Japan is a major credit donation to the rest of the world it basically invests loads into foreign
assets and so what happens in Japan is critically important to the flows of capital around the world
and at the moment the Japanese the bank of Japan has been basically saying we will cap yields on
the 10-year space at 25 basis points with the recent pullback in global yields that's taken
some of the pressure off remember when they cap healed they're effectively diluting their
currency that was Yen weakness when yield started to come back some of those kind of
global growth stories started to roll over yields fell that pressure came off Yen started to Rally
but CPI in Japan has been picking up it's been delayed relative to other regions
but it is picking up if you have inflation picking up in Japan so that real returns for
Japanese assets is actually still falling even if Global yields have already peaked
then you could still see some issues in terms of pressure in Japan the reason why that's that
matters is that because if yields in Japan go up to one percent one point five percent they
will have a knock-on effect into all other markets so U.S yields will go up European
yields will go up they might not beat the levels they've previously got to but they will still be
impacted up if Japan walks away so Japan will be watching critically its own inflation story at
the moment it's still probably within the Realms of what's acceptable but if it moves dramatically
from here then that could be a problem it feels like it should roll over but remember the energy
crisis has not gone away Japan Imports its energy needs there's a hope that that recession Global
recession can kick through and cap inflation in Japan but if we don't get the recession in the
US we don't get the global slowdown we expect then Japan could be a problem and Japan could
drive yields elsewhere higher if they have to walk away from yield curve control so hopefully
they're a very disparate group of charts that I've looked at I've focused on the US because
that should still be our own kind of core area to be looking at but there are these other issues
there is geopolitics at play there is the energy crisis at play it is a global story and commodity
prices have perhaps not been acting as we'd like them to particularly given that recently we've
been talking about China reopening we'd expect commodity prices particularly energy to pick up
it feels like that recession is a story for 2023 how deep will it be well we'll probably get an
idea from things like Aussie dollar Yen and then we'll get an idea on whether the FED can do a
pivot the reality is if we get a big slowdown today the FED can pivot early if we don't get
a Slowdown or big enough increase in unemployment particularly in the US soon then the FED will have
to probably be tighter than we expect for longer than we expect and they might have to actually
generate the recession in the back end of next year if we don't get it in the front end [Music]
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