2023 The year of the Water Rabbit – promises longevity, peace, and prosperity. What is reality?

Dec 7, 2022 | News, Newsletter Articles

When the citizens of Kyiv removed their corrupt president, Viktor Yanukovych, in the “Euromaidan” revolution of 2014, they underestimated how swiftly that would trigger Russian intervention which was a major fault line for the world and the global economy. Global outcomes became difficult to predict post the Russian invasion of Ukraine triggering a vastly different world on several fronts, as the free world realised that the countdown to global conflict and economic fracturing had begun.

The US Federal Reserve (FED) and other Central Banks will have their work cut out next year (2023) as their attempt to stabilise the economy by reducing consumer price inflation rather than asset price inflation, is misdirected. Investors continue to harbour hopes that the Fed will pivot from fighting inflation to supporting economic growth, leading to interest rate cuts in H2 2023.

However, the Fed’s inflation fight is far from over and rates are likely to rise further, which will put pressure on risk assets. ‘Do not fight the FED’ is never more apt, with Fed officials indicating that no pivot is in sight and that tightening may last into 2024. Markets have consistently underestimated the prospect of a more aggressive Fed in 2023. Short-term outcomes will see investors continue holding cash and avoiding risk, as a synchronised global recession implies a strong dollar, weaker commodities and eventually, even higher bond prices.

The vexing issue for European investors is the call that the “worst is over” despite the fact that the cold season has only just started. The meteorological winter began on 1 December, while the astronomical winter does not start until 21 December. The end of November offered a preview of how a crisis could develop in the coming months. Across Europe, the wind nearly stopped, forcing the grids to lean in on gas-fired power stations and, in Germany, on coal. In the past, the French nuclear industry bridged the shortfall, exporting electricity to everyone. But France was importing power as many of its reactors have been down for repairs, further tightening the market.

From now on, a period with little solar or wind electricity and high demand because of low temperatures is likely to see the dreaded scenario in Europe – as Germans call it a Dunkelflaute ‘the dark doldrums’ – unfolding. If a Dunkelfluate episode hits Europe, the region will struggle. The grid operators would have to ask consumers to cut demand to avoid blackouts or they will experience SA style rolling blackouts. A cold economic winter is beckoning in 2023 and one can add the UK to this gloomy picture despite BREXIT.

While markets speculate as to global Central Bank rate increases, for China (and by default SA), it is the ZCP ‘zero-Covid policy’ which is fermenting market unease. Provided China does not implode on the back of rising protests, a better outlook for EM is on the horizon, aided by attractive valuations and eventually a less hawkish Federal Reserve.

Chinese markets rallied as President Xi’s “less lethal” comment and fresh policy adjustments fuelled another wave of buying. ‘ZCP’ is clearly his policy and any surge in COVID deaths will cause a loss of face. Thus, three years after the pandemic began in the city of Wuhan, the often-draconian non-pharmaceutical restrictions known as “lockdown”, remain in place. Why? Firstly, they need to overcome anti-vaccine sentiment amongst the elderly population, as according to the National Health Commission, thirty-two million over-60s (12%) and eight million over-80s (22%) have never been vaccinated at all and ICU beds number fewer than five per 100,000 people.

Secondly, President Xi is more ideological than his predecessors and believes that his mission has shifted to reframing how a free-market system should work by reining in excessive competition, ring-fencing the financial system from crises, and setting up rules for “Orderly competition.”

In China, protests are making a reappearance in multiple Chinese cities which is of great consequence as, like elsewhere, ‘the restless’ have played a revolutionary role on more than one occasion in the past. Xi keeps reminding Chinese people of his “four confidences” namely that Chinese people should have self-confidence in their chosen path, guiding theories, political system and culture. Xi has also aggressively promoted “socialist core values” to counter the free market’s tendency toward individualism. Failing the placating of the restless population, Xi Jinping may deflect and seek to salvage the Party’s legitimacy by picking a fight abroad – Taiwan?

Therefore, in 2023, we can anticipate further uncertainty and more of “common prosperity” type regulations and continued disregard of investor rights. As a result, Chinese stocks may, in the longer term, trade at a meaningful discount to global peers! Never underestimate the power of the revolutionary masses, it has unseated kings, emperors and presidents over centuries.  Xi’s rejection of the concept of civil society, economic neoliberalism and journalistic independence makes investing in China a fraught undertaking.

Meanwhile, SA continued to score own goals as the SARB highlighted that external issues were impacting financial stability in the country including geopolitics and emerging market capital outflows. The bank’s chief concern locally is the country’s unreliable and inadequate power supply, noting that it could have an impact on the financial stability of the country. Load-shedding has a substantial negative impact on local economic growth, investor sentiment and general business activity, which the SARB believes is exacerbated by other pre-existing vulnerabilities.

In 2023, the SA economy must invest in infrastructure to make business ‘purr along effortlessly’ including transport, education and skilled training. Furthermore, the market is overly dependent on the good will of foreign lenders to keep the country’s payment balances stable yet produces little to sell internationally; we are losing market share because of poor infrastructure and regulation. Just as markets thought Cyril Ramaphosa was a shoe in to lead the ANC / SA, now further uncertainty prevails, as the Section 89 panel recommended impeachment proceedings against the President.

So, does 2023 see Cyril Ramaphosa step down as President? Not likely – and If history is any guide, then tough political and constitutional decisions await SA. ANC parliamentary history dictates that while it is still possible that impeachment may happen, it is unlikely given that the impeachment committee would have to decide on that. Also, two thirds of the National Assembly would have to support such a finding, according to Section 89 of the Constitution (ANC parliamentarians stood by Zuma despite damaging findings). The looming damage to Parliament’s status, reputation and standing will be dire and any continued uncertainty will rattle the ZAR.

SA politicians are themselves operating with few facts and decision-making is exceedingly difficult. We are in no better position to determine political outcomes and see little value in doing so due to the high forecast risk. As the lost decade under Zuma highlighted, the economy adapts and adjusts to economic realities despite political uncertainties.

After a sharp rise in domestic real rates, we believe that the SARB has now reached the top of the rate cycle. Despite this, cyclical headwinds are intensifying and a hard landing in household consumption forms our base case for 2023. Of great concern outside of foreign flows, is research which shows that in 2022, 43% of the total SA population earned less than ZAR 4000.00 pm, up from 29% in 2019. Also, the ‘middle class’ as an entity (a big percentage are civil servants) uses 66% of their disposable income for debt repayments. July ‘insurrection’ and a deeply indebted middle class remain a key known / unknown variable in 2023.

In summary, an asset price collapse seems to be inevitable. It is only a matter of time. The prospect of a cold economic winter with higher interest rates for longer does not bode well for risk assets, as they lead to economic slowdown and hurt corporate profitability. In a portfolio context, we remain underweight equities, equal weight bonds, commodities and emerging market currencies (ZAR). We remain committed to our long-term strategies and would encourage our clients to do the same.

Finally, thank you for your continued support – enjoy the festive season and be safe.

Mark Huxter – December 2022