How Likely is Recession Across Markets?

Dwindling central bank liquidity, the ongoing conflict in Ukraine and a rolling deglobalisation trend all look set to shape investment market fortunes throughout 2023 with varying degrees of recession likely across major markets, says BNY Mellon Investment Management senior strategist Lale Akoner.

According to BNYM IM senior strategist and Global Economic and Investment Analysis (GEIA) team member Lale Akoner, three key trends will likely influence global investment prospects in 2023.

One of the most consequential long-term themes, in terms of markets and investments, says Akoner, will likely be the financial deleveraging associated with the end of the quantitative easing (QE) era and shrinkage of central bank balance sheets.

Elsewhere, Akoner points to the ongoing impact of the Russian/Ukraine conflict on energy prices and wider regional economic growth.

Despite its earlier incursion into Crimea, the full-blown invasion of Ukraine by Russia was something that had been unthinkable for many. It marked the end of a European peace dividend we have been enjoying – to a greater or lesser extent – since the fall of the Berlin Wall in 1989,” she adds.

Finally, a third key trend driving economic change, adds Akoner, is a steady erosion of globalisation. She adds that this appeared to gather pace during the Covid-19 pandemic and has since further disrupted supply chains. In turn, this has resulted in the supply of many goods and services moving closer to home markets, creating more insular local and regional economies, exacerbating inflationary pressures.

These key trends, posits Akoner, have contributed to high inflation and recession risks across major markets.

Recession risk

We believe major central banks have decided that it is worth risking a recession to control inflation. As a result, markets seem to have moved away from the inflation story, as we believe we are now at peak inflation for major economies. Instead, for 2023, markets and investors will likely try to gauge the length and depth of recession in major economies. That, in turn, will make a key difference to the way individual stock markets and the companies they list perform,” she adds.

Akoner believes the US faces about a 60% chance of recession but that its underlying economic strengths may mean it recovers more quickly than other major markets such as Europe and the UK, which she thinks face deeper recessionary threats. Any US recession, she adds, may prove a “job plentiful” one, with higher levels of employment than are usual in economic downturns – even if some job losses appear inevitable.

US consumers and corporates appear to be much better positioned financially than those in Europe and some other markets, thanks to their higher level of deposits and built-up pandemic savings. There is a chance of a soft economic landing for the US and that make us more optimistic overall on American prospects than on those for the other main developed markets,” she says.

Commenting on Europe, she adds: “In contrast to the US, Europe was arguably already in recession as the year ended and we believe it has a 70% chance that will continue in 2023. That said, there is a lot of differentiation across individual European countries in terms of how long that downturn will be. France, for instance, is in better condition vis a vis its energy resources than some other European Union (EU) countries and there are other widespread regional and national variations across the EU.”

Inflation threat

Akoner believes overall high inflation will persist in the year ahead, with the Fed continuing its aggressive interest rate stance in a concerted bid to tackle inflationary pressures. She does, however, see some signs for economic optimism and believes core inflation is coming under control in the US, even if it still remains high in Europe and the UK.

Beyond rising inflation and potentially inflationary wage growth in Europe, Akoner says the Eurozone faces a direct ongoing economic threat from the war in Ukraine. Despite some impressive efforts from some EU countries to substitute other fuel sources for Russian oil and gas, she believes Europe remains vulnerable to fuel shortages and both policymakers and bankers will be hoping for a mild winter.

Temperature, weather changes and the severity of the European winter ahead will be very important to both investors and the European Central Bank (ECB) policy making,” she adds.

Some countries – such as those in the Nordic region – are naturally more vulnerable to cold weather, resulting in higher energy consumption. Against this backdrop, sustainability issues will be important for policy makers and investors in the months ahead.”

Akoner acknowledges the current inflationary picture and high volatility levels in global stock markets are deeply unsettling to investors. Yet she also believes the chances of a major market event triggering wider contagion and a stock market collapse in a ‘something breaks’ scenario are fairly low with a likelihood of only 10%.

Looking towards 2023 and through the current challenging conditions, she still believes investors should be able to pinpoint some attractive opportunities through careful stock and credit selection. Akoner also believes some investment sectors such as consumer staples, energy and healthcare are relatively insulated against margin pressures and may outperform on a sectoral basis.

Concluding on the likely outlook for bond markets she adds: “While inflation is expected to persist, for credit especially, we believe active issuer selection is key in seeking exposure to firms with healthy balance sheets which are able to stand a higher interest rate environment.”

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